Marat Terterov-Doing Business With Russia (Global Market Briefings) (2004)

GLOBAL MARKET BRIEFINGS
doing business with
RUSSIA
A GUIDE TO INVESTMENT OPPORTUNITIES

& BUSINESS PRACTICE
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Contents
Foreword
xi
Andrew B Somers, President, American Chamber of Commerce in Russia
List of Contributors
Map 1: Russia and its Neighbours
Map 2: Russia and its Regions
Map 3: Moscow and its Boundaries
Introduction
Marat Terterov
xv
xxv
xxvi
xxv
xxix
PART ONE: BACKGROUND TO THE MARKET
1.1
Developments in the Political Environment
William Flemming
1.2
An Overview of the Russian Economy: Money Matters
11
Raiffeisen Bank
1.3
The Legal Regime and Regulatory Environment for

International Business
30
CMS Cameron McKenna
1.4
Latest Developments in the Foreign Investment Climate
38
Andrew B Somers, President, American Chamber of Commerce

in Russia
1.5
The Russian Investment Climate
42
Branan
1.6
Russian Country Risk: Clouding Future Prospects for

Russian Corporates
55
Elena Anankina and Robert E Richards, Standard & Poors

PART TWO: THE FINANCIAL SECTOR
2.1
The Russian Banking System: An Overview
69
Eric Zuy, Allen & Overy
2.2
Retail Banking
79
Deloitte & Touche
2.3
Twelve Years of the Russian Insolvency Regime
82
2.4
The Issuance and Regulation of Securities
91
Max Gutbrod, Partner, Baker & McKenzie CIS, Limited
2.5
Currency Regulations
Vladimir Dragunov, Partner, Baker & McKenzie CIS, Limited
95
2.6
Corporate Governance Development in Russia
99
Branan
PART THREE: MARKET POTENTIAL
3.1
Russian Oil and Gas
109
Bill Page and Mark Redhead, Deloitte
3.2
The Business Climate in the Russian Oil and Gas Sector
115
Keith Rowden, Leader, Energy Industry Services and Igor Lotakov,

CFA, Senior Manager, PricewaterhouseCoopers
3.3
The Oil and Gas Industry: The Regulatory Environment and

Legal Infrastructure
123
CMS Cameron McKenna
3.4
Investing in a Reforming Electric Utilities Industry
128
Alexander Chmel, Partner and Vyacheslav Solomin, Senior Manager,

PricewaterhouseCoopers
3.5
Russian Energy Sector Policy
136
Sergey Maslichenko, OTAC Limited
3.6
The Telecommunications Market
146
Vyacheslav Masenkov, Deputy General-Director and

Alexander Chachava, Senior IT Analyst, RBC
3.7
Telecommunications: The Regulatory Framework
164
CMS Cameron McKenna
3.8
The Russian IT Market
168
Vyacheslav Masenkov, Deputy General-Director and

Alexander Chachava, Senior IT Analyst, RBC
3.9
The Automotive Industry
174
Alexander Raifeld and Andrei Kouzmin, Deloitte & Touche
3.10 The Pharmaceuticals Market
180
Anton Timergaliev, Senior Market Analyst, RMBC
3.11 Investing in Russian Pharmaceuticals: Crisis or Renaissance? 190

Denis Matafonov, Analyst, Antanta Capital
3.12 The Development of Retail
198
Alexander Raifeld and Andrei Kouzmin, Deloitte & Touche
3.13 The Brewing Industry
205
Deloitte & Touche

PART FOUR: GETTING ESTABLISHED:
THE TAXATION AND LEGAL ENVIRONMENT
4.1
Business Structures
217
CMS Cameron McKenna
4.2
Establishing A Presence
225
CMS Cameron McKenna
4.3
Russian Business Entities

Gennady Odarich, Lawyer, PricewaterhouseCoopers
CIS Law Offices BV
231
4.4
Business Taxation
241
Paul Quigley, Deloitte & Touche
4.5
Russian Taxation
250
Natalia Milchakova, Tax Partner, PricewaterhouseCoopers, Moscow
4.6
Auditing and Accounting
265
Andrei Elinson, Deloitte & Touche
4.7
New Russian Customs Legislation
275
Alexander Dragunov, Director, Customs Practice,

PART FIVE: BUSINESS DEVELOPMENT:
OPERATING AN ENTERPRISE
5.1
The Property Regime in Russia
283
CMS Cameron McKenna
5.2
Land Relations in the Russian Federation
289
Andrey Goltsblat, Managing Partner, Pepeliaev, Goltsblat & Partners
5.3
Intellectual Property and E-Commerce
294
CMS Cameron McKenna
5.4
Arbitration and Dispute Resolution
304
CMS Cameron McKenna
5.5
Employment Law and Work Permits for Expatriates
311
CMS Cameron McKenna
5.6
An Investment Project in Russia: Applicable Laws
317
Andrey Goltsblat, Managing Partner, Pepeliaev, Goltsblat & Partners
5.7
Entrepreneurial Start-ups
326
Jamison Firestone, Firestone Duncan
5.8
Property Rights
333
Andrei Soukhomlinov, Partner, Baker & McKenzie CIS, Limited
5.9
Competition Law
344
Paul Melling, Partner and Sergei Voitishkin, Partner,

Baker & McKenzie CIS, Limited
APPENDICES
Appendix 1: Learning from the Russian Experience: Regional Debt

Defaults and Recovery 19982003
353
Eugene Korovin and Elena Okorotchenko, Standard and Poors

Ratings Direct
Appendix 2: Placing Investment Projects within the Context of

National Significance
366
Vitaly Mozharowski, Partner and Maxim Popov, Senior Attorney,

Pepeliaev, Goltsblat & Partners
Appendix 3: Useful Business-Related Websites

Appendix 4: Contributor Contact Details
Index
Index of advertisers
371
374
379
391
Foreword
It is my pleasure, for the second consecutive year, to introduce this
very useful and respected volume containing the viewpoints of
international companies operating in Russia. A number of the
contributions will refer to the positive macroeconomic indicators
and the remarkable legislative reform progress that have begun to
attract the serious attention of investors to Russia. In my Foreword, I would like to emphasize the significant support that private
business has been receiving from the joint co-operation between
the US and Russian governments on economic and trade policy.
Most importantly, the US and Russian governments have developed a strong institutional relationship that facilitates the
progress that we see today.
A number of initiatives provide the opportunity for Russian and
foreign business to influence government economic policy with the
overall goal of improving the Russian climate for investment and
trade. The American Chamber of Commerce in Russia is an active
participant in many of these efforts. One such initiative in the
energy sector is the US-Russia Commercial Energy Dialogue
(CED), a private sector process that operates under American and
Russian co-chairs representing their respective business communities. Five working groups, led by American and Russian companies,
address specific areas of bilateral energy co-operation, including
investment, market access, transportation, small business and
electricity. In the past year, these working groups produced specific
recommendations presented at the second US-Russia Commercial
Energy Summit in St. Petersburg in September 2003, which were
condensed into a shortlist of priority tasks. The US side has already
responded to one of these tasks by assuring the Russian government that the US market and regulatory regime could accept a
significant increase in Russian oil imports. The construction of a
pipeline from western Siberia to the northwest port of Murmansk
will facilitate the delivery of oil from Russia to the United States.
We are optimistic that the CED will continue to make inroads into
both governments policy-making process.
Another example is the Russian American Business Dialogue
(RABD), which focuses on such issues as intellectual property
rights protection; customs code implementation, and the improvement of the environment for small business. Private business has
scored some successes in this area in terms of improved regulatory
and legislative steps by the government, and the American
Chamber of Commerce will continue to press on those issues.
A third sector that has benefited from this co-operation is healthcare. Along with the US Commerce Department and the RF Health
Ministry, our Chamber leads the Russian-American Interagency
Council on Harmonization in Healthcare. The Council held a series
of workshops for Russian professionals from the Health Ministry
that focused on Western practices in the area of medical devices
and pharmaceuticals regulation, and harmonization of quality
systems and standards. For 2004, a work plan has been developed
that includes more workshops, exchange visits and publications.
I mention these public-private sector co-operative processes to
emphasize that the reforms of the Russian government and the
new relationship between the United States and Russia are being
supported by an open dialogue between the private sector and both
governments in terms of formulating policies that are conducive to
business and to improving the investment climate.
I trust that you will find the expert contributions in this volume
of significant importance, as they outline the dynamic Russian
economy and provide insightful forecasts for its continued growth.
Andrew B Somers
President, American Chamber of Commerce in Russia
List of Contributors
Allen & Overy is a premier international law firm and was founded
in 1930. With over 4,800 staff, including some 430 partners, working in
26 major centres worldwide, they are able to provide effective, co-ordinated and decisive legal advice across three continents. Their clients
include some of the worlds leading businesses, financial institutions,
governments and private individuals. Their aim is to understand business objectives and to be considered a critical arm of any organization
they become involved with.
Eric Zuy, Senior Associate, Allen & Overy Legal Services, Moscow,
has advised major Western banks, financial consortiums and companies
on different types of banking transactions, project finance, and different
financial arrangements with respect to insolvency and securities regulations. Erics experience also includes advising on various types of
secured lending, trade and export finance, financial and commercial
transactions. He has broad experience of restructurings and insolvency
procedures relating to banks and corporates. Prior to joining Allen &
Overy, Eric was heavily involved in legal arrangements of foreign investments in the Russian Federation, transactions involving exchange
control regulations, finance, corporate and insolvency matters.
The American Chamber of Commerce in Russia celebrates its
10th anniversary in 2004. Representing more than 750 member
companies, the Chamber has established itself as one of the largest
and most influential foreign business organizations in the Russian
Federation. With its Moscow headquarters, its St. Petersburg chapter,
and representatives in Washington DC, the Chamber advocates
members interests to the Russian and US governments, and provides
a forum for dialogue between the international business community
and policy-makers. The Chamber is a lead organization of the RussianAmerican Business Dialogue, initiated by Presidents Bush and Putin
as a vehicle for the private sector to make recommendations to both
governments on how to reduce barriers to trade and investment. The
Chamber also co-chairs the US-Russia Commercial Energy Dialogue,
the US-Russia Information Technology Roundtable and other important forums to advance business in Russia.
Andrew B Somers has been President of the American Chamber of
Commerce in Russia since December 2000. He is the American co-chair
of the US-Russia Commercial Energy Dialogue and a leader of the

Russian-American Business Dialogue. He was Executive Vice President
and General Counsel of American Express TRS Company in New York
and headed his own consulting firm specializing in real estate and
financial transactions in the Russian regions. His wife, Marina, is a
partner in Somers & Cavelier, a Moscow-based executive search firm.
Antanta Capital Group started active operations in the Russian
equity market in 2003. Since then it has become one of the fast
growing private investment companies in Russia.
Although the company is young, it has already demonstrated good
business results: in December 2003, Antanta Capital was rated 7th by
RTS with a trade volume of over $145 million. Antantas area of expertise is second-tier stock, which will become one of the most profitable
investment options on the Russian equity market. Antanta Capital
provides private investors and corporate clients with a full range of
brokerage and financial services in the domestic and international
stock markets. Contacts:
Arthur Alekyan, Director: aalekyan@antcm.ru
Eugene Kogan, Executive Director: ekogan@antcm.ru
Andrey Babenko, Head of Sales and Trading: ababenko@antcm.ru
Vladimir Lounkov, Head of Research Department: vlounkov@antcm.ru
Baker & McKenzie is an international network of more than 3,200
locally qualified, internationally experienced lawyers practicing in 68
locations worldwide. Over the years, their goal has been to offer clients
the best of both worlds wide-ranging global experience with in-depth
expertise, and practical know-how in the laws and legal systems of the
local jurisdictions, in which they are located. The significant size and
level of development of the firms world-wide practice ensures that they
are, at all times, able to provide required resources from their worldwide
network to complement their local offices. Combining more than 30 years
of experience in Russia and the CIS, with a network of full-service offices
in Moscow, St. Petersburg, Kiev, Almaty and Baku, Baker & McKenzie
has the resources it takes to help clients capitalize on the wealth of business opportunities in the region. Their key practice areas include arbitration/litigation, banking & finance/securities, corporate law/M&A,
IT/Telecom, intellectual property, labour/employment, natural resources,
pharmaceuticals industry, real estate/construction, tax, venture capital.
Vladimir Dragunov is a partner in Baker & McKenzies Moscow
Office. He earned his Bachelor of Law with High Honors (1997) from
the International Law Department of the Moscow State Institute of
International Relations (MGIMO). He has also received an LL.M.
degree in Banking and Finance (with a merit) at the University of
London (UCL) and has worked for nearly two years in the Finance
Department of the firms London Office. Prior to joining Baker &
McKenzie, he worked for a Russian law firm, specializing in various
commercial, corporate and foreign investment issues. Since joining
Baker & McKenzie in 1997, he has been practising as a banking and
finance lawyer. His primary focus is on bank and corporate lending,
secured transactions, pre-export and trade finance, structured finance
and securitization, derivatives, custody and currency control regulations. He has also broad experience in mergers and acquisitions as well
as in capital markets work. In addition to his native Russian, he is
fluent in English and has basic German.
Max Gutbrod is a partner in Baker & McKenzies Moscow Office.
Dr Gutbrod is a member of the firms International Corporate & Securities Practice, as well as of the CIS Banking & Finance and Natural
Resources Practice Groups. He also heads Baker & McKenzies CIS
IT/Telecommunications Practice. He is a member of the Financial
Committee of Baker & McKenzie. He is Deputy Chairman of the
German Business Association in Russia and Chairman of its Financial
Services Committee. He is also a board member of the Russian Franchising Association. Dr Gutbrod is a graduate of the University of
Tubingen and the University of Munich. In 1992, he earned a Ph.D.
from the University of Munich. Dr Gutbrod joined Baker & McKenzies
Berlin Office in 1993 and has been practising in Moscow since 1995.
He regularly advises on corporate and commercial matters, joint
ventures, banking, securities and finance matters and government
regulations. He is a frequent speaker at conferences on banking and
finance, currency control, oil & gas, WTO issues, and the securities
market in Russia. Dr Gutbrod has written numerous articles
regarding Russian, German and international business law, including
WTO, privatization, securities transactions and banking. In addition
to his native German, he is fluent in English, Russian and Portuguese.
Paul Melling is the Managing Partner of the Moscow office of
Baker & McKenzie. He supervises the firms Corporate/M&A Practice
in Russia and heads the CIS Pharmaceuticals Industry Practice. Mr
Melling is an English lawyer and the founding partner of Baker &
McKenzies Moscow office, having been resident in Moscow since
January 1989. He is a graduate of Oxford University and joined Baker
& McKenzie in London in 1980 as a member of its East-West Trade
Department, specializing in trade and investment in the then Soviet
Union. In 1982, he became one of the first Western lawyers to appear
before the USSR Foreign Arbitration Commission in litigation
governed by Soviet Law. Mr Melling has been the Honorary Legal
Adviser to the British Ambassador in Moscow since 1990 and the
Honorary Legal Advisor to the Association of International Pharmaceutical Manufacturers in Moscow since its establishment. He is also
Honorary Legal Advisor to the Russo-British Chamber of Commerce

and a member of the Chambers Executive Council. He is fluent in
English and Russian.
Andrei Soukhomlinov is a partner in the Moscow office of Baker
& McKenzie. He heads the firms Real Estate & Construction Practice
in Russia. He joined Baker & McKenzies Moscow office in 1997. Mr.
Soukhomlinov has advised on acquisitions and sales of real estate,
commercial property leasing, land use and planning, as well as on the
real estate aspects of corporate mergers and acquisitions and lending
secured against real estate. He received his Law Degree with Honors
from Moscow State Institute of International Relations (MGIMO) in
1987. Prior to joining Baker & McKenzie, Mr. Soukhomlinov worked
for several years as a legal adviser in a Russian real estate development company and also advised on real estate and construction
matters while working for a Russian law firm. He speaks fluent
English in addition to his native Russian.
Sergei Voitishkin is a partner in Baker & McKenzies Moscow office
and heads Baker & McKenzies Russian M&A Practice. Mr Voitishkin
earned his law degree from the Law Department of the Moscow State
University in 1997. He also holds a degree in linguistics from the
Moscow Institute of Foreign Languages. He specializes in corporate
and commercial law matters. He served as a lead attorney on a
number of multi-million dollar M&A transactions in Russia, advising
major multinational and Russian clients on mergers and acquisitions
in various industries, including oil and gas, manufacturing, chemicals,
domestic appliances, tobacco and food products. The European Legal
500 Law Firms in Europe & the Middle East 2003 refers to Mr
Voitishkin as a respected partner recommended for M&A work in
Russia. In addition to his native Russian, he speaks fluent English and
Swedish.
Branan is a Russo-British management consulting and corporate
finance firm based in Moscow and with a strong focus on Russia.
Branan provides services to clients in a wide range of industries,
including energy and utilities, telecoms/media/technology, and manufacturing. The firms main services are: strategy and organization;
marketing and sales; financial management and accounting; mergers,
acquisitions, disposals and capital raising. Since its formation in 1999,
Branan has successfully completed more than 100 projects in Russia,
Ukraine, Kazakhstan and Uzbekistan. The firm now employs over 40
people in offices in Moscow and Kiev.
CMS Cameron McKenna is a leading international law firm and a
market leader. The firm has been recognized in several prestigious
awards including most recently British Consultant of the Year

British Consultants Bureau in 2000 for work on a water treatment
project in Sofia, and the same award in 1999 for work on an airport
project in Africa. CMS Cameron McKenna has practices in Central and
Eastern Europe with offices in Moscow, Warsaw, Budapest, Prague and
Bucharest and affiliated offices in Belgrade and Bratislava. CMS is a
transnational legal services organization with member firms in the
UK, Germany, France, Austria, Belgium, the Netherlands and Switzerland, and with 44 offices in 19 different countries.
Deloitte Touche Tohmatsu is an organization of member firms
devoted to excellence in providing professional services and advice. It
is focused on client service through a global strategy executed locally
in nearly 150 countries. With access to the deep intellectual capital of
120,000 people worldwide, its member firms, including their affiliates,
deliver services in four professional areas: audit, tax, consulting, and
corporate finance. Its member firms serve more than one-half of the
worlds largest companies, as well as large national enterprises, public
institutions, locally important clients, and successful, fast-growing
global companies. Deloitte has over 800 local and expatriate professionals working in its offices in CIS countries: in Moscow, St. Petersburg, Kiev, Minsk, Baku, Tbilisi, Almaty, Astana, Atyrau, Bishkek and
Tashkent. In the CIS, Deloitte provides a full range of professional
services to both multinational corporations and growth-oriented local
firms, including audit, tax and legal, corporate finance, consulting and
corporate governance services. Its mission is to help its clients and its
people excel.
Andrei Elinson joined Deloitte in 1997. He is an Audit Manager in
the Moscow office of Deloitte & Touche CIS and has been working with
the CIS practice for more than five years. Andrei has spent six months
working in Deloittes Forensic Department in the UK. In 2002 Andrei
became the Forensic Leader of the Russian firm. He is also a member of
the quality control group of the firm and serves as Deputy to Professional Practice Development Partner of our CIS Practice, who is responsible for treatment of Russian Accounting Standards. Andrei has served
a wide range of local and international clients demonstrating a thorough
knowledge of Russian, international and US accounting and auditing
standards. Before joining Deloitte, Andrei also served as an expert in the
stock department of DIAM Bank, Moscow for one year, where he honed
his skills in securities trading and stock market valuation of various
manufacturing clients. Andrei is a Certified Public Accountant and an
Associate Member of Association of Certified Fraud Examiners.
Andrei Kouzmin has extensive experience in developing strategies
for clients in various industries. He is skilled in market segmentation
and analysis, competitor analysis, strategic diagnostic, marketing and
sales improvement, competitive positioning, distribution channel

development and project feasibility studies. He has also assisted
clients in improving their business operations, organization design
and development. Andrei has specialized in supply chain management, business process improvement, and corporate restructuring
issues. He has strong experience in financial modelling and cost
management. Before joining Deloitte, Andrei was a consultant in the
supply chain management practice at PWC Consulting, and was previously an associate in the US with Coopers & Lybrands cost management group. He holds an MBA degree in International Strategy from
Georgetown University, Washington, and a Diploma in English and
German from Kaluga State Pedagogical University.
Bill Page is tax leader for the oil and gas industry in the CIS. Bill
has been practising tax for 17 years and for nearly five years in the
CIS. He is a graduate of Oxford University and prior to joining the
accounting profession was a tax inspector with the UK Inland
Revenue. Bill has extensive experience in development and implementation of tax strategy and tactics for multinational and local energy
companies, negotiation of hydrocarbon contracts, management of due
diligence and tax reviews of target companies for foreign investors,
management of various financing and business-related issues
including optimization of trading operations for oil and gas companies.
Bill has also worked extensively with construction and oilfield service
companies, providing advice on cross-border transactions, support in
negotiating with the local tax authorities and supporting clients
involved in litigation on tax issues.
Paul Quigley is a VAT manager in the Indirect Tax Group in
Moscow. Originally from the UK, he has been working in Moscow since
2001 and has wide experience of VAT both in Russia and the European
Union. Paul serves a wide variety of clients from different industry
sectors. Paul has specialized in VAT for the last six years. He started
his career working with the UK tax authorities as a VAT inspector in
the City of London. Before joining Deloitte, he also worked for another
Big Four firm and in industry.
Alexander Raifeld is a Consultant in the Consulting Department
of Deloitte in Moscow. He joined the firm in 2002. During his work with
the firm Alexander participated in strategy development for retail and
financial sectors and managed teams of business analysts. He developed a growth strategy for Russias largest wholesaler of household
items to increase corporate long-term value. Working closely with
senior management of the largest Russian childrens toy retailer, he
conducted an extensive operations optimization project. He also participated in number of projects for Deloittes main FMCG clients.
Alexander graduated from Tufts University, Medford, Massachusetts
and holds degree in Economics and Eastern European Studies.
William Flemming has been based in Moscow for the past five years,
providing analysis of the Russian political scene in a variety of capacities. Prior to moving to Moscow, he was a graduate student of Oxford
University doing research on Russian politics. He is currently opinion
page editor of The Moscow Times.
Firestone Duncan is a midsize Moscow-based provider of highquality legal, tax, accounting, and audit services and it maintains an
affiliated office in Khabarovsk (the Russian Far East). The partners
are American and Russian and the firm has been in operation since
1993.
Its areas of practice include most areas of Russian law that are
likely to be of interest to corporate clients and entrepreneurs. The firm
also maintains strong litigation teams. Several of Firestone Duncans
professionals have been trained to give expert testimony in the UK
courts regarding matters of Russian law and have participated in
international arbitration cases in various European forums. Firestone
Duncan is able to undertake multi-jurisdictional projects and its abilities are enhanced by its membership in TagLaw, a worldwide network
of prominent high-quality law firms. The professional members of
Firestone Duncan speak Russian and English and are governed by
western norms of professional responsibility, confidentiality and
ethical conduct.
Jamison Firestone is also a Member of the Board and CoChairman of Enterprise Development Committee, AmCham.
OTAC Ltd, which was incorporated as a UK registered company in
mid-1999, brings together a variety of overlapping and complementary
consultancy experience and skills in a close-knit group that can also
draw on a wide network of associates. OTAC was founded by Peter
Oppenheimer, who is one of the most respected advisers and commentators on Russias transition, combining the academic standards of
Oxford University with wide-ranging experience of public bodies and
business corporations.
OTAC personnel provide high-level support to governments, international institutions and private sector clients on strategic issues and
the management of change. They offer wide-ranging experience on the
key aspects of economic and social change:
economic, social and institutional reform and national and regional
strategies;
development of broad-based growth and regeneration strategies;
energy Sector Reform, including overall strategy and detailed
reviews of specific industries and issues;
strategic sectoral reviews ranging across manufacturing and
service sectors and covering industries from automobiles to tourism;
public sector finance and civil service reform, including povertyfocused strategies;
government and institutional communications, public diplomacy
and information.
Sergey Maslichenko is involved in OTAC Ltd. as a senior consultant. Over the last year he has been team leader of several FCO
projects in Russia and Kazakhstan specializing in energy strategies.
He has wide international experience of working in the field of energy
policies, including consultancy work for the Ukrainian government. He
got a PhD from Kiev National Economic University and carried out
post-doctoral research at Oxford University in 2002/2003 as an FCO
Chevening Scholar.
The lawyers of Pepeliaev, Goltsblat & Partners provide assistance
in regulating rights to land plots and other real estate assets, and in
solving other legal and tax problems. They specialize in:
land and real estate due diligence, including examination of title
documents for land and property;
privatization of land and real estate;
legal support for land and real estate transactions (purchase and
sale, lease, mortgage, etc);
drawing up contracts and negotiating contractual terms with counteragents;
arranging an independent appraisal of land and real estate;
acquisition of rights to land plots intended for commercial use;
acquisition of rights to existing manufacturing facilities for setting
up production;
real estate mortgages as security for obligations under commercial
contracts.
PricewaterhouseCoopers (www.pwc.com) is the worlds largest
professional services organization. Drawing on the knowledge and
skills of more than 120,000 people in 139 countries, Pricewaterhouse
Coopers builds relationships by providing industry-focused assurance,
tax and advisory services based on quality and integrity. The objectives
of its service offerings are to build trust and enhance value.
PricewaterhouseCoopers applies its industry knowledge and professional expertise to identify, report, protect, realize and create value for
its clients and their stakeholders. PricewaterhouseCoopers serves
many of the leading businesses in every sector on which it focuses.
Those businesses value its rigorous, practical approach, characterized
by a detailed understanding of individual client issues and by deep
industry knowledge and experience.
In Russia PricewaterhouseCoopers has representative offices in

Moscow, St. Petersburg, Togliatti and Yuzhno-Sakhalinsk. PricewaterhouseCoopers offices are also situated in other CIS countries: Azerbaijan, Kazakhstan, Estonia, Latvia, Lithuania, Moldova, and Ukraine.
Raiffeisen Bank Austria (Moscow) is a leader in Russias financial
services market, providing a broad range of commercial, retail, foreign
exchange, investment banking and brokerage services to both resident
and non-resident corporate and private clients. RBA (Moscow) has
been operating in Russia since 1996. A wholly-owned subsidiary of the
Raiffeisen Banking Group, it was the first Russian bank with 100 per
cent Austrian capital to have been granted a General Licence by the
Central Bank of the Russian Federation.
RosBusinessConsulting (RBC) is Russias leading media and IT
company. It was created in 1993, and is currently the number one business information provider in Russia, as well as one of the major developers of software solutions for large and medium-sized businesses.The
company has the widest business audience in the Russian media.
RosBusinessConsulting was among the first Russian information
agencies to create its own web portal (www.rbc.ru), which is now
among the top three most popular resources on the Russian Internet.
The website contains a wide variety of information and analytical
materials on different segments of the market, which is available both
in free and restricted access. RBC applies its extensive experience
gained in the process of development and promotion of its own projects
for the creation of IT solutions for its clients. RBCs highly-qualified
specialists are able to develop and install various software, which is
indispensable for the successful operation of large companies and state
organizations. Direct targeting of web resources, along with high user
hit rates, allows RBC to control more than half of the Russian
Internets advertising market.
Presently, there are over 1,000 specialists working for RBC, of whom
more than 400 are highly-qualified IT engineers, web developers,
programmers, designers, analysts and consultants. RBC is a source of
independent, reliable and current information, which helps its
subscribers (over 5,000) achieve success in a wide range of activities.
RBC supplies state organizations, major Russian and foreign companies and the leading mass media with the widest range of information
and news products. These consist of real-time news, financial data from
Russian and world exchanges, RBC marketplaces, numerical, textual
and graphical databases plus specialized financial tools for analyzing
the market, analytical commentaries, corporate and branch research.
Some 600 corporate reviews and over 100 industry surveys on all
manufacturing industries have been published by RBCs analytical
departments over the last five years. The largest databases and news
agencies of the world distribute RBCs information: Bloomberg L.P.,
Bridge, LEXIS-NEXIS and Factiva (Dow Jones & Reuters). Dozens of
clients who have used the services of RBCs analytical departments
include the Russian Atomic Energy Ministry, Rosbank, Sumitomo
Corp., NEC, Hitachi, Caterpillar, PRS-Presottorino Shatura, Radio
Liberty, Dell, Sun Microsystems, and Russian regional administrations.
RMBC Company (Remedium group of companies) was founded
in 1999. It is a leading market research and business consulting
company on the Russian pharmaceutical market. In November 1999,
RMBC won a tender organized by the Association of International Pharmaceutical Manufacturers (AIPM) on Retail Audit of drugs in Russia. At
present the company has two subsidiaries, in Nizhniy Novgorod and in
St.Petersburg, and 25 regional representatives in the regions. RMBCs
primary goal is providing clients with the most up-to-date and full information on the Russian pharmaceutical market. Since 2003 it started
operation in the CIS countries (Ukraine, Belorussia, and Kazakhstan in
2003) In 2002 RMBC became the first company on the Russian pharmaceutical market, whose methodology of statistical reports was approved
by international audit company Deloitte & Touche.
The major activities of RMBC are various market researches,
including portfolio analysis, positioning and promotion strategy development, identification of a new market niche etc; preparation of standard statistic reports covering pharmacy sales, hospital purchases and
pharmaceuticals prescription; rent-a-rep service; monthly market
bulletin published in co-operation with AIPM; analytical support of
Remedium publishing house periodicals Remedium, Rossiyskie
Apteki as well as the website: www.remedium.ru.
The major players, over 45 leading pharmaceutical companies of the
Russian pharmaceutical market, are among RMBC clients: among
them are Russian as well as foreign manufacturers Pfizer, MDS, Glaxo
SmithKline, Boehringer Ingelheim, AstraZeneca, Organon, Nycomed,
Lek, KRKA, Hoffmann La Roche, Schering, Schering Plough, Solvay
Pharma, Boots, Servier, Schwarz Pharma etc.
Standard & Poors was created in 1941 when a merger of Standard
Statistics and Poors Publishing Company took place. It is possible to
trace its roots to 1860 when Henry Varnum Poor published his History
of Railroads and Canals of the United States. Mr Poor was a leader in
establishing the financial information industry on the principle of the
investors right to know. Today, more than 140 years later, Standard &
Poors is the pre-eminent global provider of independent highly valued
investment data, valuation, analysis and opinions and is still delivering on that original mission.
Map 1: Russia and its Neighbours
Map 2: Russia and its Regions
Map 3: Moscow and its Boundaries
Introduction
Dr Marat Terterov
This is now the third edition of Doing Business with Russia that I
am introducing as editor, and it coincides with the very recent reelection as Russian president of Vladimir Putin, who convincingly
won the vote for his second presidential term in March 2004. With
Putin seemingly at the height of his political power having been
elected as the Russian Federations second president in March 2000
and appearing set to remain president until at least March 2008
and with the Kremlin seemingly having asserted such a strong
level of influence over Russian political and economic life during
Putins first term, what are the most pressing questions
confronting international business as it contemplates market
opportunities in Russia during Putins second term? There are two
lines of discussion through which I would like to take the reader
when contemplating this question, in addition to the general issues
of doing business with Russia. The first of these is political, while
the second pertains to the question of business culture.
The political
As international companies either already working with, or
seeking to work with, Russia witness the commencement of Putins
second four-year term in office, several notable political (or policymaking) trends emerging from the first term are likely to consolidate and continue setting the framework for operations in the
country. During the 1990s, under the presidency of Putins predecessor, Boris Yeltsin, Russias image as a destination for international business was marred by perceptions of economic stagnation
and political instability. As the reader of previous editions of this
book may recall, the established foreign view of Russian economic
and business highlights during the Yeltsin decade was in fact one of
low-lights, where production fell drastically in many vital sectors
of the economy, where foreign and domestic investment was
outstripped by capital outflow, and where social turbulence precipitated by economic shock therapy (reforms) and financial crises
seemed pervasive. Economic and political uncertainty in Russia
during the 1990s was further complicated by the States inability
or unwillingness to turn back the tide of organized criminal organizations engulfing the business sector, as well as the ongoing war
in the break-away republic of Chechnya, which the government
claimed was associated with terrorist acts against the population
in several of Russias cities, including Moscow.
If stagnation and instability were the main themes driving the
foreign investors perception of Russia during the Yeltsinite 1990s,
recovery and stabilization appear to be the hallmarks of Putins first
term. Although Russia analysts will recall that Putin was initially
appointed Prime Minister in August 1999 by Boris Yeltsin to bring
the costly violence associated with the ongoing war in Chechnya
under control, from the perspective of the foreign investor, Putins
first term as president will be remembered as a time when the
Russian economy came under the management of a seemingly more
diligent team of technocrats, who were able to realize consistently
high rates of growth between 2000 and 2004. The Russian economy
has been growing since the August 1998 financial crisis, reaching an
annual high of 8.3 per cent in 2000. Average annual growth during
the remainder of Putins first term was in the region of 5 per cent,
and, amidst the post-September 11 downturn in the US, these
figures have been well received by many foreign critics. One of
Putins stated objectives for his second term has been to double
Russias GDP within 10 years. Such policy objectives and figures are
certainly attractive for international business, as Russias consistent years of economic growth, comparatively inexpensive cost of
labour and high levels of human capital, together with improved
levels of stability, are becoming noticed internationally.
A further defining trait of Russian politics under Putins first
term has been his governments continued acceleration of the
economic reforms instigated during the Yeltsin years. Under Yeltsin,
expulsion of prime ministers and changes of key government
personnel was commonplace. During Putins first four years in
office, however, the Russian government has committed itself to
encouraging the private sector, reducing bureaucratic controls on
commercial activities, encouraging foreign investment, and further
integrating Russia into the global economy by engaging in
continued dialogue over Russias entry into the World Trade Organization (WTO). A number of laws enhancing the process of economic
liberalization have been passed under Putin, including a reduction
in the countrys tax on incomes to a flat 13 per cent, an overhaul of

Russias land code to one better geared to facilitating private property transactions, simplification in the procedures for the registration of new companies and the introduction of a new labour code
governing employerworker relations. Such reforms, although in
their early stage of influencing Russias overall investment climate,
are nevertheless strengthening the countrys business environment
and capturing the attention of foreign investors.
Russias enhanced image among the international community is
further reinforced by the emerging confidence of the Russian business community, which, during the Putin years, has been reinvesting much of its profit back into the domestic economy.
Although without doubt much of the economic growth mentioned
earlier has been contributed by Russias high-profile oil and gas
industry (and high world prices for oil), a number of domestic enterprises from a diversity of spheres of economic activity are also
performing visibly well. For the first time since the disbandenment
of the Soviet Union, investment coming into Russia has overtaken
capital flight out of the Russian Federation, and the big Russian
corporations in oil and gas, the energy sector, metallurgy, telecoms, and food processing are now tending to buy up existing
assets and enterprises to further expand their business within the
country. Major Russian companies such as Lukoil, Yukos, Gazprom,
AvtoVaz, Norilsk Nickel, the electricity giant UES, Severstal,
Sibneft, Vimpelcom and Tatneft are among the key drivers of the
countrys improved economic performance during the Putin years.
Twelve Russian companies including those mentioned above
were recently listed among the worlds largest corporations in
Forbes magazines annual rankings of the worlds 2000 largest.
Leading Russian companies are demonstrating their commitment
to enhancing their management strategies by increasingly
employing graduates from some of the top foreign business schools
and universities, using foreign consultants to restructure their
enterprises, and seeking to improve their understanding of
concepts such as corporate governance. Although foreign investment in Russia still remains at relatively low levels compared to
some neighbouring emerging markets, the reduction of capital
flight and the reinvestment of domestic capital back into Russia
has provided a substantial boost for the economy and has created
many new jobs, particularly in the manufacturing sector. Furthermore, while the top Russian corporates dominate the business
headlines, many secondary tier companies (some of which the
reader will encounter in this book) are also seeking to operate to
international standards and looking to expand their relationship

with foreign business.
The Wests positive appraisals of Russias domestic economy and
business environment during Putins first term reached a peak of
sorts in mid-2002 when the government of the United States
proclaimed Russia to have acquired the status of a market economy.
The American governments decision was based on a ruling from the
US Department of Commerce, which carried out an extensive
review process in arriving at its decision, that proclaimed that the
Russian economy had transformed from its socialist past and was
substantially driven by market forces. Also in the summer of 2002,
the reputable international credit ratings agency, Standard &
Poors, upgraded Russias rating from B+ to BB- (a rating that
Russia last held prior to the August 1998 financial crisis), assigning
a stable investment outlook and justifying its claim on the basis of
continuing economic reforms and improved budgetary discipline.
Similiarly, another major ratings agency, Moodys, accorded Russia
with an investment grade rating in October 2003. Furthermore, the
Russian government and a number of private industry lobby groups
have been actively staging numerous international business conferences in Europe and North America promoting Russia as a destination for foreign investors. The positive reviews that Putins economic
team have received during his first term have also been accompanied by some practical results in terms of attracting international
business to Russia and numerous (major) international companies
have a commercial presence of one form or another in the country.
The Yukos case

It is evident, then, that during the period of Vladimir Putins first
term as president the Russian government made a clear effort to
improve the business environment in the country and concentrated
notable energies into likewise improving the countrys economic
performance. Although a noticeable degree of good fortune has been
on the side of the governments economic managers in recent years
(ie, it is widely regarded that the Russian economy has been
growing on a wave of favourable prices for oil and other raw materials upon which the countrys exports are dependent), Russia, as a
business opportunity, is arguably viewed more favourably today
than at any time since the Soviet Union faded into history.
However, while the positive signals are apparent from a business
perspective, many critics are likewise concerned that Russian liberalism had reached a crisis during Putins first term, while the
countrys nascent forces of socio-political plurality gave way to the

Kremlins newly asserted State centralism. Liberalism has never
been a concept deeply rooted in the Russian national character, and
although liberal economic reformers and self-proclaimed
democrats were prominent in Russias initial years of economic
transition, such individuals are widely associated with the
countrys present social and economic problems. During Putins
first term, while the Russian government sought, selectively, to
continue with economic reforms, the State became a more aggressive regulator of the economy than it had been under Yeltsin and
exercised its preponderance over market forces when it determined
that the latter had not acted in the national interest. The most
evident example of the States over-exuberance in its efforts to
regulate the market has been the governments partial nationalization of Russias leading oil company, Yukos (in October 2003), and
the arrest of its leading shareholder and Russias richest private
individual, Mikhail Khodorkovsky.
Much has been written about the Russian States recent pogroms
against both Yukos and Khodorkovsky in the international press
and the reader will further be able to gauge the opinions of a
number of well-qualified commentators with regards to the Yukos
case inside this book. The Russian government has justified its
action by claiming that leading Yukos shareholders including
Khodorkovsky had been involved in illegal privatization transactions during the 1990s and have grossly evaded their tax commitments, which, given the net value of Yukos assets, has indirectly
contributed to the economic deprivation of millions of Russian citizens. However, there is a wide degree of consensus among analysts
that the States attack on Yukos resulted from Khodorkovskys
increased activities in national politics (his funding of liberal opposition political parties, his public criticisms of the Russian political
establishment, his alliances with Western capital and governments) and the potential challenge this may have created for the
Putin regime. In terms of the the crisis of Russian liberalism, what
is important from the Yukos case is not that the Russian government under Putin is showing any intention of reversing the inexorable process of economic liberalization that has been taking place
in the country for well over a decade. Rather, we are now seeing a
Russian political establishment that is promoting economic reform
and courting international capital at the same time as expanding
administrative controls over both the market and political orientations advocating a liberal nature that have been emerging in
Russia during recent years. While in the short term such policies
are, at best, sending confusing signals to foreign investors contemplating the Russian market, in the long term they are clearly in
contradiction to what the West would like to see take root in
Russia, as the former is firmly grounded in an ideology of the noninterventionist, unbiased State acting as an impartial referee in an
open marketplace functioning within a liberal political framework.
Business culture
The Yukos case is also instructive for the foreign investor from the
perspective of the type of business culture prevailing in Russia.
Although the Russian government has sought to improve the
countrys investment climate in recent years, and has, indeed, supervised an improvement in macroeconomic management and monetary stability, it has yet to create an institutional environment for
business where the rules of the game apply equally to all parties.
The application of such a philosophy in business life is one of the
central features of the mature market economies of Western countries and something that the West has long been trying to impress on
governments in countries like Russia. The arrest of Mikhail Khodorkovsky and the States sequestration of a substantial part of his
shareholdings in Yukos is, unfortunately, demonstrating that politicians in Russia are able to clamp down on businessmen when the
latter, for whatever reason, fall out of favour with the State. It must
be remembered that the same justification that the government
employed to arrest Khodorkovsky, prosecute him through the courts
and drive the countrys second largest oil company towards
bankruptcy could have been applied to numerous other leading
Russian businessmen who continue to operate freely in Russia today.
Personalities, rather than institutions, have remained the dominant
feature of Russian business culture from Yeltsin to Putin, whether
the subject of analysis is focused on the countrys president and
richest man respectively, or a regional state official and a local businessman somewhere in the vast Russian hinterlands. This aspect of
Russian business culture is summed up in the following comment,
which the reader can examine in more detail in Chapter 1.6 of this
book: Instead of institutional frameworks serving as the foundation
for fair and efficient economic activity, the application of laws and
regulation in Russia is driven by personal agendas and rivalries and
self-preserving or rent-seeking bureaucracies.
It is evident that relationships count for a great deal when
seeking to conduct successful transactions at a commercial level in
Russia, something that a foreign business should keep strongly in

mind when conducting its due diligence into the Russian market.
From a commercial perspective, many of these relationships are
transacted somewhere inside, or on the fringes, of government
bureaucracy and usually involve some level of rent-seeking
behaviour, a widespread form of economic corruption more often
referred to as bribery in the West. Although in the Wests mature
market economies State bureaucracy is built on a tradition of individuals providing government services to the private sector and
receiving a middle class income from the State, in both the Soviet
Union and Tsarist Russia such traditions for the most part failed to
entrench themselves. Instead, an individuals incentive to enter into
a bureaucratic career in Russia has, historically, been motivated by
the potential of gaining access to State resources and acquiring
social status that accompanies holding a public office. Access to the
States resources, complimented by the political power that has
traditionally accompanied the position of public office, has, over
time, facilitated the emergence of rent-seeking bureaucracies in
many ex-socialist countries. A culture of bribery, where bureaucrats
exchange the States goods and services for informal rents, or
bribes, from private citizens, has been pervasive in Russia for
centuries, and has shown little sign of abating in more recent years.
Although Vladimir Putin has firmly stated his governments intentions to fight bribery and economic corruption, and aimed to reduce
the size of the countrys bloated public sector during the first term of
his presidency, there is little sign that any tangible success has been
achieved in this sphere. This aspect of Russian business culture was
summed up by a headline in the well-regarded English language
Russian newspaper recently: Kickback culture is a way of life (The
Moscow Times, 28 January 2004).
Nor has Vladimir Putins government been able to disassemble
Russias business oligarchy and ownership concentration of the
countrys major economic assets from the narrow set of hands that
control it. Russias oligarchs, or business tycoons, emerged as the
dominant players in the countrys economy during the mid-1990s,
when a group of these individuals colluded to finance Boris
Yeltsins re-election campaign in 1996 in return for the States
complicity in their acquisition of Russias crown jewel public sector
enterprises at highly undervalued prices. Despised by millions of
ordinary Russians, who blame these individuals for their own
present economic misfortune, Russias oligarchs consolidated their
prominence during the latter years of Yeltsins presidency. When
Putin became president in 2000, it was initially felt by many that
he would bring the oligarchs to heel and perhaps create an

economic climate where Russias economic wealth could be, to some
extent, deconcentrated and disbursed throughout the economy and
society in a more equitable manner. This was especially the case
early on during Putins presidency, after he effectively drove two of
the leading oligarchs of the Yeltsin era, Boris Berizovsky and
Mikhail Gusinsky, out of the country into foreign exile. However,
although it is possible to argue that Putins campaign against the
oligarchs reached a new peak after the governments crackdown on
Yukos, Russias president has, for the most part, failed to break the
countrys oligarch-dominated economy.
This conclusion is confirmed by a recent study published by the
World Banks Moscow office, which argues that ownership concentration of Russias economic assets is just as evident today as it has
been in the 1990s. The study found that just 23 individuals or
groups control more than a third of Russias industry, 16 per cent of
employment and 17 per cent of banking assets, and confirms the
power of a few homegrown corporate operators when seen in the
context of the Russian economy as a whole. Such studies point
towards a two-fold conclusion: that the Russian economy during the
Putin years continues to be dominated by either monopolistic or
oligopolistic business groups operating within an underdeveloped
competitive framework and weak anti-trust culture; and that the
governments attacks on certain leading business figures have not
constituted an attempt to break the oligarch-dominated economy,
but, rather, bear greater resemblance to politically-motivated witchhunts against selected targets that have fallen out of favour with
the political establishment. Clearly, such an economic setting, where
commercial success is highly dependent on political patronage, and
where there is not one set of rules that can be applied equally to all
players, can be quite a difficult one for most foreign enterprises to
navigate. It also goes a long way towards explaining why Russia, as
a country of such vast economic potential, has been a relatively poor
performer in its efforts to attract foreign direct investment (FDI).
Despite some of these polemics that will confront international
companies seeking to do business in Russias unorthodox business
culture, Russia is destined to continue to attract foreign investors
into its nascent market. Russias overall improved economic and
political performance under Putin, the pro-global economic policies
of his government and major Russian corporations, together with
the countrys abundant supplies of many of the worlds most vital
natural resources, all make the present time a particularly attractive one for embarking upon business co-operation with this vast
country. Furthermore, the businessman or woman can no longer

speak of their arrival in Russias major European capitals such as
Moscow or St Petersburg as a lawless or exotic encounter with
early post-Marxist society. Even the first-time visitor to the country
is likely to be surprised at just how much of the West has now
happily settled in present-day Russia. All the standard symbols,
goods and services found in the most dynamic market economies
are likewise found in contemporary Russia. Goods and services of
every kind imaginable are both traded between Russia and the
outside world, and produced inside the country. Street trading is
particularly active in Russias large, multicultural cities, rekindling
memories of Russias early capitalism in the late 19th and early
20th centuries. Russia today is a vast market populated by millions
of avaricious consumers who are proving extremely resolute in
finding the necessary disposable income to enthusiastically sample
whatever new goods and services the market can offer them.
Furthermore, despite Russias relatively poor performance in
attracting FDI, many large foreign businesses are already well
established in the Russian market. Among them are some of the
worlds biggest multinationals including Swedens furniture
company IKEA, which has been in the country for over a decade,
the American giant of the automobile industry, General Motors,
which has recently invested heavily in the Russian car industry, as
well as Swiss-based Nestle, Frances Danone, and the UKs British
Petroleum, which in March 2003 announced a $6.75 billion planned
investment in a joint venture with the Russian oil company TNK.
Although this is a market where a foreign entity is far more likely
to establish itself as part of a multinational company rather than a
small- to medium-size enterprise, it is inevitable that more foreign
companies will be coming to Russia in future years. As global business expands further, such companies will be attracted to Russia on
the basis of market opportunity as well as by the many success
stories of foreign businesses such as some of the companies
mentioned above, which put their confidence in Russia years ago
and are now seasoned veterans of conducting business in the
country. Most of these enterprises entered Russia with a long-term
plan for their investments and have been flexible enough in their
business strategies, adapting to some of the requirements of the
local business environment. They have managed to demonstrate
that, despite the complex nature of the Russian investment
climate, Russia is a country where foreign companies can do
business and reap the rewards in this highly prospective and
challenging, emerging market.
About the book

In this volume, our third attempt at compiling a comprehensive
publication on Russian business since the August 1998 financial
crisis, the reader will find over 40 separate chapters covering a
wide diversity of business topics relevant to one of the worlds most
significant countries. Furthermore, in keeping with the publishers
tradition of upholding objectivity and a range of specialist opinions
with regards to a particular country, these articles are contributed
by a great diversity of authors, all specialists in their particular
area of doing business with Russia.
In Part One of the book, we present the reader with a comprehensive economic, legislative and political background to the
Russian market. Contributors in this section include Austrias Raiffeissen Bank and the international law firm CMS Cameron
McKenna, who focus on the countrys economic and federal legislation as it relates to business and investment practices. There are
also contributions from the Moscow-based political commentator,
William Flemming, the Russian company Branan, and the President of the American Chamber of Commerce in Russia, Andrew B
Somers, who discuss the Russian political system during the Putin
presidency and present in-depth chapters addressing the Russian
investment climate. We also present a chapter by the international
ratings agency, Standard and Poors, on Russian country risk.
In Part Two we focus on the Russian financial sector and include
chapters by the law firm Allen & Overy on banking and insolvency,
while Deloitte & Touche present a chapter on the status of retail
banking in Russia. Branan also provides a detailed commentary on
the latest trends in Russian corporate governance, and the international law firm Baker & McKenzie discusses currency regulations
and the securities market.
Although most goods and services are today readily available in
most large Russian centres of population, the countrys consumer
market is still very underdeveloped by international standards.
Ample opportunity still exists for international companies to supply
the Russian market. In Part Three, therefore, authors from PricewaterhouseCoopers, Deloitte & Touche, CMS Cameron McKenna and
several local specialists review some of the more high-profile sectors
of the Russian economy, including extraction industries such as oil
and gas, reforming industries such as the electricity sector, and
other traditionally important sectors such as automobile production
and pharmaceuticals. We also look at some of the newer, dynamic
sectors, including telecoms and the IT sector, retail and brewing.
In Parts Four and Five our lawyers, accountants and tax specialists provide an overview of Russias tax regime and accounting
practices, as well as intellectual property, the new land code, the
recent overhaul in the labour code, the real estate market, the new
customs code and other relevant topics.
The book is also complimented by an appendices section that we
hope the reader will find useful, with its business briefs, some additional statistical information about the Russian market, and its
collection of internet pages providing further practical information
relevant to this once enigmatic country.
Dr Marat Terterov
July 2004
Part One
Background to the
Market
1.1
Developments in the
Political Environment
William Flemming
Introduction
Governing the Russian Federation a country that spans 11 time
zones, with approximately 145 million inhabitants and covering
almost one-seventh of the worlds land mass presents a formidable
challenge for any Russian president. This resource-rich country
stretches from the Pacific Ocean to the Baltic Sea and from the Arctic
Circle to the Black Sea and China. The Russian Federation came into
being in 1992 as the Soviet Unions legal successor state, and since
then has not enjoyed the smoothest of transitions from a totalitarian
political system and centrally-planned economy to democracy and the
free market.
In March 2004, Vladimir Putin won re-election with an overwhelming first-round majority of 71 per cent of the vote a victory that
cements his personal dominance of the Russian political system. As
Putin enters his second presidential term, the course of the countrys
development will be dictated by him and his protgs to a much greater
extent than was the case at the beginning of his first term, when he
was still a relative political novice with an unconsolidated power base.
Some four years after effectively being installed in the presidency by
Boris Yeltsin and his inner circle, it could be said that Putin is finally
his own man.
However, Putin also goes into his second term facing mounting
criticism both at home and abroad over his administrations
authoritarian tendencies and the absence of institutional checks on
his power. The political system that Putin presides over has acquired
the moniker of managed democracy and the March 2004 presidential
election, which was criticized for the lack of real competition or
substance, is seen by many as symptomatic of this systems
progressive entrenchment.
Background to the Market
This chapter looks at the political landscape and the countrys main
political institutions, and then proceeds to a brief assessment of Putins
first term in office and the prospects for his second term.
The president and the presidential administration

Russias first post-Soviet Constitution adopted in 1993 laid the
foundations for what is sometimes referred to as a super-presidential
system, in which considerable formal powers are vested in the office of
the president, in addition to which the president has an impressive set
of informal levers for exerting influence over the body politic.
According to the Constitution, the president is elected to a four-year
term and may sit for a maximum of two consecutive terms. The president sets the domestic and foreign policy agenda, is Russias top representative on the international stage, and is commander-in-chief of the
countrys armed forces. He nominates the prime minister (as well as
having extensive control over other government appointments), who
must then be approved by the lower chamber of the parliament (the
State Duma). He also has certain decree powers and can veto legislation passed by the parliament, which then requires a two-thirds
majority in both lower and upper chambers to be overturned.
Furthermore, the president has the power indeed is obliged to
dissolve the Duma if his nominee for prime minister is rejected three
times consecutively. And if the Duma passes two motions of no-confidence in the government within a period of three months, the president
must either dismiss the prime minister and his government or dissolve
the Duma.
The president has a staff of approximately 2,000 functionaries,
called the presidential administration. Inter alia, it provides Putin
with an indispensable tool for political control, and increasingly all
decisions of any importance are made by the president and his staff.
Head of the presidential administration is Dmitry Medvedev: a
member of Putins inner circle, he replaced the long-serving Alexander
Voloshin, a pivotal Yeltsin-era holdover, in November 2003.
At the time of writing, the presidential administration is undergoing
reform as part of a wider effort to slim down and revamp the executive
branch, although initial indications are that reform of the presidential
staff will be largely cosmetic and that most key figures will stay in
place. Medvedevs only two deputies in the reformed administration,
Vladislav Surkov and Igor Sechin, are members of the two main clans
in Putins entourage (thereby preserving balance inside the Kremlin).
Surkov, with ties to the Yeltsin clan, is rightly considered to be one of
the Kremlins most talented political managers and is responsible for
ensuring that the parliament, media and regional governors are all
kept in line and on message. Sechin, one of the presidents most

trusted henchmen, has been by Putins side since the early 1990s and is
considered a core member of the so-called St. Petersburg silovik group
in the Kremlin.
On the economic side of the adminstration, Andrei Illarionov, the
presidents outspoken economic adviser, has been reappointed. In
Putins first term, Illarionov was a sparring partner for the
government over economic policy and for Unified Energy Systems
CEO Anatoly Chubais (over plans for restructuring the electricity
monopoly, in particular). He is also credited as author of the ambitious
goal of doubling GDP in a decade a key objective established by Putin
in his 2003 state of the nation address and reiterated in 2004. Arkady
Dvorkovich, an able young economist and former deputy minister of
economic development, has been made head of expert department (a
new entity formed by merging the economic and expert departments of
the presidential administration), which will be responsible for
providing independent analysis of the governments economic policy
and evaluating draft economic legislation.
Under Yeltsin and also under Putin, one of the key informal levers of
influence at the presidents disposal was and is the so-called
household department (upravlenie delami prezidenta). The
department controls an empire of hotels, dachas, apartments,
chauffeur-driven cars, top-notch medical facilities, etc and is responsible for taking care of the needs of government officials, Duma
deputies, officials from the General Prosecutors Office, Supreme Court
judges, and so on. It provides the president with a rich source of
patronage and largesse, which can be (and has been) used extremely
effectively for political ends. Even the most ardent political opponents
have tended to be susceptible to material incentives offered by the
Kremlin, and this is perhaps no surprise given that official salaries
even of top government officials, judges and Duma deputies up until
now have been extremely meagre. This is now changing with the
announcement of significant wage increases as part of the programme
of government and civil service reform. It should also be added that, as
Putin has tightened his grip on the political system, this lever has lost
the importance that it once had for resolving political disputes in the
Yeltsin era.
Government
Although the Russian Constitution has a number of features in
common with the French Constitution of the Fifth Republic (both of
which provide for a form of dual executive), the main difference in
practice at least has been the preponderance of the Russian president
over the parliament in forming the cabinet. Throughout the post-Soviet

period, with the exception of the short-lived cabinet of Yevgeny
Primakov, the government has depended on the president for support
rather than resting independently on a parliamentary majority. As a
result, the government has always been the junior partner in the executive, possessing limited political weight and lacking a proper political
base of its own. During the Yeltsin era, this was reinforced by the presidents efforts to consolidate his own position through frequent prime
ministerial sackings, cabinet reshuffles and playing cabinet members
off against one another.
Mikhail Kasyanov was prime minister for practically the duration of
Putins first term. Owing his appointment more to the Yeltsin clan than
to Putin, he retained some measure of independence, publicly
disagreeing with the president on a number of key issues. While he
proved to be a competent manager, presiding over an impressive period
of economic growth, he dragged his feet on key reforms, including
administrative and civil service reform. Indeed, this served as the
official pretext for Kasyanovs dismissal just three weeks before the
end of Putins first term and his replacement by Mikhail Fradkov, a
former minister of trade and director of the federal tax police, who was
ambassador to the EU at the time of his appointment.
The choice of Fradkov, which came as a complete surprise to most
people, was probably determined primarily by four factors. First, he is
seen as someone who will loyally implement the presidents wishes.
Second, he is an experienced bureaucrat. Third, he is a convenient
compromise figure: not only is he acceptable to the key groups in
Putins entourage (without being a full member of any of them), but he
is also a known quantity in the West and has enough of an economics
background not to spook the markets. Fourth, he is seen as having no
political ambitions of his own. The general feeling is that Fradkov will
last for no more than a couple of years, after which Putin will probably
replace him with his anointed heir, someone from the presidents inner
circle.
Most of the key ministers responsible for the economy have retained
their seats in the Fradkov government, including Finance Minster
Alexei Kudrin and Economic Trade and Development Minister
German Gref. Moreover, the powers of both have been enhanced in the
reshuffle and restructuring of the government, with the Tax Ministry
being subsumed by the Finance Ministry and the Customs Committee
and Property Agency being incorporated into Gref s Ministry.
Two new faces in the Fradkov government, set to play an important
role, are Alexander Zhukov, the deputy prime minister in the new
government, and Dmitry Kozak, cabinet chief of staff. Zhukov, who
served as a Duma deputy for over a decade and as chairman of the
Dumas Budget Committee from 1998 until his government
appointment, is a respected liberal economist. Kozak, one of the more

industrious reformers in the presidential administration and a close
Putin associate, is probably the most powerful head of the government
apparatus in post-Soviet Russian history. In addition to his core duties,
he heads the government commission on administrative reform and is
responsible for the implementation of sweeping reforms of the
government and civil service (an area that Putin has repeatedly named
as a top priority for his second term). He is also the Kremlins enforcer
in the Cabinet, responsible for ensuring that there is no deviation from
the presidential line (in official bureaucratese, he is responsible for
ensuring the unity of the system of executive power). The powers
conferred upon the prime ministers nominal subordinates Kozak, in
particular have led some observers to question the extent to which
Fradkov will really be in charge of the government.
The programme for overhauling Russias bloated bureaucracy and
reforming the government is still being thrashed out at the time of
writing. However, the effectiveness of the executive branch and its
capacity to implement policy will depend to a considerable extent on
the success or failure of this crucial reform.
Parliament
Russia has a bicameral parliament, the lower chamber being called the
State Duma and the upper chamber, the Federation Council. The
Duma is made up of 450 deputies (MPs), half of whom are directly
elected in first-past-the-post contests and half of whom are elected
through party lists. Duma elections occur once every four years,
providing the president does not dissolve the lower house before it
serves out its full term (under one of the scenarios outlined above in
the section on the president).
For most of Yeltsins period in office, the Duma was dominated by the
Communist Party and its satellites, while pro-presidential forces were
weak in number. As a result, the executive and legislative branches
were frequently at loggerheads and relations at best were characterized by grudging co-operation. Yeltsin never invited the parliamentary opposition to form a government, although he did from time to
time appease the communists by removing ministers whom the opposition considered particularly odious and sometimes even co-opted
individual members of left-wing parties into government. In the
Yeltsin years, the government managed to push a certain amount of
important legislation through parliament, normally through a mixture
of cajoling and carrot and stick methods. However, frequently the price
was the emasculation of legislation or its capture by powerful interest
groups.
The parliamentary elections in December 1999 fundamentally

altered the balance of forces within the Duma, with pro-Kremlin
parties strengthening their position considerably and the left opposition losing its prior dominance over the legislative process. The
Kremlins majority was further consolidated in the December 2003
parliamentary elections, in which the pro-presidential United Russia
party won a resounding victory and emerged with more than 300 seats
under their control giving it a large enough majority to initiate
constitutional amendments. United Russias leader, Boris Gryzlov,
became speaker of the parliament following the elections; he is viewed
very much as a loyal executor of the Kremlin line, rather than an independent player.
The only other parties to get into the new Duma were the
Communist Party, Rodina (Motherland) and Vladimir Zhirinovksys
LDPR the latter two parties both purvey a mixture of nationalism
and populism, and both are creatures of the Kremlin to a greater or
lesser extent. Thus the only real opposition comes from the communists (with just over 50 deputies) but even their opposition is somewhat
half-hearted. The liberal Union of Right Forces and Yabloko parties
crashed and burned in the elections, failing to even clear the five per
cent threshold necessary for representation in the parliament.
While the pro-Kremlin parliamentary bloc looks increasingly monolithic, appearances may well be deceptive. Many United Russia
deputies have multiple allegiances, enjoying close ties or being
beholden to the regional or business elite (numerous representatives
of regional governors or major companies were included on United
Russias party list in return for financial and/or administrative
support). Thus, while it is very unlikely that there will be open defiance
of the Kremlin or the government, there certainly will be plenty of
lobbying and horse-trading going on behind the scenes. Another issue
is whether the party can outlive Putins presidency, given that it has no
real programme beyond supporting Putin.
The Federation Council, until Putins accession to the presidency,
was composed ex officio of the governors of each of Russias 89 regions
and the speakers of regional legislatures (ie 178 members in total).
This provided the regional elite with additional clout at the federal
level, as well as the ability to block federal legislation that did not serve
their interests. The upper chamber has the power to veto legislation
and send it back to the lower chamber, with a 2/3 majority then being
required to override the veto, which under Yeltsin was very difficult to
achieve.
One of the first major reforms undertaken by Putin following his
inauguration in May 2000 was to weaken the governors by, inter alia,
depriving them of their seats in the Federation Council (thus depriving
them of their immunity from prosecution as well). This reform did not
require amendment of the constitution, as the constitution itself is

rather vague, stating only that: The Federation Council consists of two
representatives from each of the regions of the Russian Federation; one
each from the legislative and executive branches of the government.
Thus, governors and heads of regional legislatures have been replaced
by full-time delegates elected by them.
The Federation Council has effectively been transformed from a
hotbed of opposition to the federal government in the late Yeltsin years
to a subservient body under Putin that does little more than rubberstamp legislation. The speaker of the Federation Council is the
accident-prone Sergei Mironov, whose chief qualifications for the job
seem to be his blind loyalty to the president and his St. Petersburg
provenance.
The Putin presidency

Looking back at Vladimir Putins first term in office, his main
achievement for better or for worse has clearly been the consolidation of his own position and the subjugation of rival centres of power
and influence to the Kremlin, whether it be the regional governors, the
oligarchs, the media, parliament or even the government. There can be
little doubt that Putin now controls the commanding heights of the
polity. Putin has concentrated a great deal of power in the Kremlin and
in his own hands, and there are very few, if any, institutional checks or
balances; the political landscape has been purged of virtually all opposition. While this is unhealthy and gives considerable cause for
concern, it should also be said that given the chaos and the weak state
(captured by powerful business interests) that he inherited from his
predecessor, Putin had little choice but to re-centralize power to some
extent in order to strengthen the States capacity to implement policy
and reforms.
The big question, going into his second term, is whether Putin will use
the power he amassed in his first term to push ahead with crucial
reforms and seek to institutionalize his power, or whether he will merely
continue to concentrate more power in his hands and avoid establishing
transparent rules of the game. As Standard & Poors ratings agency
stated in a recent report: At the moment, it is unclear whether Russia is
poised for progress or will regress into an environment where businesses
operate under the threat of political intrigues, personal power plays and
ineffective or parasitic bureaucrats.
There are worrying indications, from the past four years, that Putin
much prefers backroom deals and strong-arm tactics to rules or laws
applied openly and across the board. The ongoing Yukos saga provides
a perfect example of this. The charges of fraud, embezzlement and tax
10
evasion against Mikhail Khodorkovsky and one of his business associates could clearly be made against any number of other oligarchs
and businessmen. Russias richest man was singled out most probably
because he got ideas above his station (particularly in the realm of
politics) and because by striking at one of the biggest and most
powerful businessmen in the country, Putin could send a clear message
to all the rest. However, rather than dealing with the excessive power
and political influence of big business (a very serious problem) by
tackling corruption, strengthening the anti-monopoly agency, introducing campaign finance legislation etc, and then enforcing one set of
rules across the board, the president has demonstrated a preference for
striking arbitrarily with the assistance of the General Prosecutors
Office. While he has whacked several individual oligarchs over the
past four years, Putin has shown no great desire to dismantle the
system or to create a more transparent system governing relations
between business and the State.
As Putin embarks upon his second term, however, there is some good
news. The Fradkov government has announced a potentially farreaching programme of reforms to revamp the government and
streamline the bureaucracy. The predatory activities of government
agencies and corrupt bureaucrats are a major source of risk impinging
on the business environment and blocking the creation of a nationwide
level playing field for business. Progressive legislation is often blocked
at the implementation phase or subverted to suit the rent-seeking ends
of individual bureaucrats. Putin has repeatedly highlighted this
problem over the past few years, reiterating that administrative
reform is a top priority for his second term, and now he seems to be
moving forward. However, without major progress on this front, the
whole reform effort will likely be stalled indefinitely.
1.2
An Overview of the
Russian Economy:
Money Matters
Raiffeisen Bank
Over the last four years international oil prices have fluctuated in the
range of $2327 per barrel, boosting Russias annual exports to
$105135 billion, or more than a third of gross domestic product. In
turn, swelling export proceeds have significantly fortified reserves,
setting the stage for exchange rate stabilization, and have fed into the
money supply, making a play with the interest rates. The major impact
of these trends on the real sector was giving a push to a consumption
and investment boom, and counteracting tendencies toward autarchy
in technology and R&D. Back in the monetary sphere, the impact of
Russias export boom has been most dynamic and visible in two major
patterns that have persisted into 2004.
First, for about the last year, the rouble has been strengthening in
nominal terms against the dollar, supported by both strong fundamentals at home and the weakening of the greenback around the
globe. Second, interest rates have shifted down significantly. This is
true not only regarding international assets, in the wake of monetary
loosening by the US FED and the general ascent of emerging bond
markets, but also domestically, due to increasing liquidity, surging
demand for nominal assets, the lack of derivatives, and declining
currency risks.
Growth in the real sector has more or less become conventional
wisdom, and the main question now is not will there be growth? but
how much?. At the same time, the monetary sphere in Russia is
becoming the most intriguing one. Broadly speaking, investors and
market players have been pondering over all three fundamental
monetary issues: the exchange rate, inflation and the interest rate.
On this note, we will assess each issue individually and lay out our
vision of future trends and their impact on the economy.
12
Exchange rate
However beautiful the strategy, one should occasionally look at the
results
Winston Churchill
We really dont need to play up the importance of this particular issue, as
the figures speak for themselves (see Figure 1.2.1). The rouble-dollar
rate lies at the crux of any analysis of exchange rate trends for Russia.
Among foreign currencies, the greenback still has pride of place in
Russia. Looking at the current account, over 50 per cent of goods are
exported in dollars or dollar-pegged currencies, and the similar share of
imports is recorded in dollar terms. Domestically, 33 per cent of households and 56 per cent of corporate deposits are set in foreign currency,
which is still mainly dollars. Turning toward the debt market, 80 per cent
of sovereign bonds, 75 per cent of corporate bonds and the vast majority
of domestic loans are issued in dollars as well. Based on both domestic
and international trends, we are likely to see another 1518 per cent of
real rouble appreciation against the dollar for 2004, on the back of last
years figure of 17 per cent. (At the same time, against the euro, the
rouble depreciated by 0.6 per cent in real terms, on a y-o-y basis).
With the roubles rapid nominal ascent against the dollar becoming
one of the key features of economic development in Russia, the future
direction of the exchange rate has become a pressing question. The
broad answer is that the oil prices will be the primary driver of the
exchange rate, while in the short run (over the next twelve months),
250
200
150
100
Real Rouble Exchange Rate

(R/$, January 99 = 100)
50
0
Jan-97
Jan-98
Jan-99
Jan-00
Jan-01
Source: Reuters, Raiffeisenbank estimates
Figure 1.2.1 Real rouble exchange rate (R/$)
Jan-02
Jan-03
Jan-04
13
the factor of major importance will be the policy mix chosen by the
Central Bank of Russia (CBR).
Our forecast for the average oil price in 2004 is $27/bbl (see Figure
1.2.2). Accordingly, if current trends persist, we should see nominal
rouble appreciation against the dollar continue. However, the actual
figure will solely depend on CBR policy. Based on the current trends we
could see the exchange rate at the level of R27.0/$1 or even lower by the
end of the year.
40
35
30
25
20
15
Brent oil price, $/bbl
10
5
0
Jan-96
Jan-97
Jan-98
Jan-99
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Source: Reuters
Figure 1.2.2 Brent oil price

Beyond the current year, there is a strong possibility that the oil price
trend will reverse itself, which would result in a lagged reversal of the
nominal exchange rate, perhaps as early as next year. Consequently,
the risk of currency weakening though greatly diminished at present
still exists for Russias assets and should be taken into account for
any investments beyond a one-year horizon.
What can the CBR do in the shorter-term perspective, while oils
remain high? Broadly speaking, the play will again depend on what
authorities view as most preferable appreciation of the domestic
currency through its exchange rate nominal values, or through accelerating inflation. The authorities are likely to base their targeted values
for each of these parameters on what would be less distorting for
domestic economic growth.
On the margin, the choices are the following:
1. Fix the exchange rate implicitly at a certain level, allowing only
minor fluctuations, while accumulating as many dollars on sales as
14
possible to insure against a worsening of external conditions and

reversal of the real appreciation trend.
2. Instead of establishing a target for the exchange rate, an alternative
would be making the liquidity constraint binding by targeting
measured increases in the money supply (and so reserves) within a
certain time period (eg a month).
The consequences of the first option would be a rapid undervaluing of
the rouble, with respective support of exporters and the relative cheapening of domestic inputs. Moreover, the CBR would accumulate sufficient reserves for a counter-cyclical play if and when global sentiment
on commodities markets worsens, and/or the US FED abandons its
loose monetary policy. This policy would ensure visible stability on the
FX market while building a sufficient base to maintain it in the future.
Interest rates would be poised to slide without extra regulations,
suppressed by mounting liquidity in the financial sector.
This policy could be supportive for foreign investment inflows, in the
sense that direct investors target cheap production factors on growing
markets and portfolio investors seek out arbitrage opportunities on
domestic asset price volatility. At the same time, it would also benefit
exporters, domestic producers and households with dollardenominated savings.
The main cost of this option is, as previously mentioned, an accelerating liquidity increase and growing problems with binding the excess
money and keeping inflation framed. Achieving these goals would
require regulation of interest rates, including issuing of own bonds,
open market operations, and creating and developing a derivatives
market. These measures should be implemented decisively and
without delay under this policy choice. Otherwise, inflation would
quickly spiral out of control, notwithstanding robust economic growth,
the populations increasing propensity to save in banks (see the
banking section below) and the mopping up of fiscal surpluses. In turn,
this would eat into the rouble savings of households and revenues of
domestically-oriented producers, and eventually might become
distorting for the economy as a whole, even leading to a bubble on the
domestic equity market (as investors switch over from bonds offering
increasingly negative real yields). In the worst case, price growth
significantly exceeding 10 per cent would undermine the benefits of
maintaining a cheap and stable rouble.
An additional sterilization measure could be aggressive capital
account liberalization, allowing domestic investors to freely invest in
foreign assets. However, this measure is highly unlikely, since it entails
a spike in volatility on domestic debt and equity markets due to the
constant in- and outflows of hot money something Russian monetary
authorities undoubtedly aim to prevent.
15
The second option, if implemented, would require much less effort

from the CBR to combat inflation, although it would fuel quicker
appreciation of the rouble, cutting into the dollar-denominated income
and savings of exporters and households. Moreover, it would generate
higher volatility on the FX market, both in the short and long term,
and likely push up domestic interest rates in the medium term translating into an increasing cost of capital for domestic companies.
Besides, both domestic and foreign portfolio investors would find
exchange rate arbitrage increasingly attractive, and eventually find
better options for playing on interest rate arbitrage on Russian and
international money markets (more on this is detailed below), both of
which would increase domestic asset market volatility.
Our educated guess is that in 2004 the CBR will use a kind of 50/50
policy mix: in the first half of the year the banks policies will lean more
heavily toward the first option, while in the second half more priority
will be given to the second. In both cases, we expect step-wise gradual
appreciation of the domestic currency to continue, but in the first case
the steps will be wider more broadly stretched out across time and
in the second case, steeper. For example, the rate of R28.5/$1 has been
maintained for more than a month since the end of January 2004,
suggesting that the bank is currently giving larger weight to the first
policy option.
The positive side of this strategy mix is that it would be a measured
trade-off between the benefits and costs of each individual policy and,
respectively, require improvements in financial market regulation. In
particular, this would mean developing absorption tools, since
managing inflationary trends certainly wont be a piece of cake.
Inflation
The lack of money is the root of all evil. Adapting this popular saying to
Russias current monetary situation, one could also add: and
windfall money is much hassle as well.
Over the last three months the CBRs reserves have swelled by more
than $20 billion, accelerating the growth of the monetary base and,
respectively, M2. So far, while money supply has been expanding
steadily at 4446 per cent y-o-y, official data point to inflation gradually declining from 13 per cent to 11 per cent y-o-y over the same
period (see Figure 1.2.3). Apart from the typical lag between growth in
monetary values and inflation, a possible explanation for this apparent
contradiction is the corresponding rise in demand for money, nominal
dollar depreciation against the rouble, and absorption efforts by fiscal
authorities.
16

140
120
100
Money supply, % y-o-y

CPI index, % y-o-y
80
60
40
20
0
Jan-99
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Source: Goskomstat, Raiffeisenbank estimates
Figure 1.2.3 Money supply vs CPI, y-o-y change

Barring any absorption measures, over the last quarter of 2003 the
monetary base should have expanded by approximately R330 billion
(eg the actual GIR increase adjusted for rouble appreciation). At the
same time, the CBR reported that the increase was in fact only R170
billion, suggesting that the authorities managed to absorb roughly half
of the rise in liquidity.
These data tell only half the story, however. According to the CBR,
cash on MinFins accounts with the CBR increased by R45 billion, half
the budget surplus value for the period (R106 billion in total), while
MinFins net issuance of bonds amounted to R36 billion over the
period. The only feasible explanation for the remainder of the
absorption is accumulation of financial reserves (and then either used
for external debt service, or simply stored), which at end 2003
amounted to R258 billion, R108 billion of which have been earmarked
for the Stabilization Fund, according to MinFin.
Apart from sterilization measures, slower price growth could also be
a function of the nominal dollar depreciation against the rouble over
the period (3.5 per cent over the second half of 2003 and another 2.8 per
cent within the first two months of the current year). The link between
domestic price dynamics and the exchange rate is a widespread
phenomenon, at least in the non-food sector, which to a certain extent
could explain the lower rate of overall price index growth. Abolishment
of the 5 per cent sales tax could have also played a role.
Finally the acceleration of real sector development (7.3 per cent
GDP growth in 2003 according to preliminary data) serves as a strong
anchor on price growth.
17
However, even when all the above factors are taken into account,
1520 per cent of money supply growth still remains unaccounted for,
suggesting a higher fair estimation of the level of inflation. Together
with falling or flat interest rates, this implies that either the market
will see accelerating inflation due to the lagged impact of monetary
growth in the nearest months, or that perhaps there was a slip-up in
official estimations.
Persistent inflation over 10 per cent would mean continued strong
real appreciation of the rouble, the exact level of which will depend on
the CBRs policy mix. What would this mean for the economy?
General implications of an appreciating

exchange rate for the economy
Exports and imports
Persistent rouble strengthening would threaten first of all the 45 per
cent of export revenue generated outside of the mineral sector. As for
imports, the data for the period 200003 can be used as a proxy for estimating the impact of appreciation on its levels. An increase of imports
by 1423 per cent annually within the period corresponded to real
rouble appreciation of 817 per cent against the dollar. This could be
taken as a proxy for the domestic import elasticity of the exchange
rate, though combined with the impact of income growth as well.
Growth and profits

Exporters profits would certainly suffer from declining roubledenominated revenues coupled with increasing domestic costs for
factors of production, including labour, intermediary products, energy,
etc. For non-exporters, losses would be felt indirectly, via the import
substitution effect. A prime example is light industry, where the rate of
growth remains in the range of negative 23 per cent for the second
year in a row.
Capital inflows
Exchange rate and interest rate arbitrage
With nominal rates falling, portfolio investors would increasingly seek
out arbitrage opportunities. On such a trend, borrowing money on
international rates and then buying NDF for $/R, or a rouble debt
instrument for a short term, would guarantee a positive return in
dollars. Respectively, portfolio investments are likely to flow into the
domestic market, though certain ambiguities in the new laws on
currency control still pose a barrier to entry.
18
and not only that

Apart from the exchange rate patterns, assessing capital inflow entails
several more issues that should be examined individually.
Growth of the economy
While in real terms 7 per cent growth is by itself an impressive feat,
and a comparable rate is expected in 2004, in dollar terms Russias
GDP posts around 26 per cent y-o-y growth. Any way you look at it,
these are certainly attractive figures for investors, reflecting a strongly
growing market with comparably cheap labour and capital, and a
suitable level of stability. Current examples of joint ventures in the
real sector abound, especially in manufacturing (automotive, furniture
production, construction materials, food industries, household appliances), not to mention large levels of foreign investment already
poured into the oil sector and planned for telecoms.
In particular, rising relative costs would be compensated for, one
way or another, by emerging opportunities and trends associated with
economic expansion (growth in market size, demand, availability of
resources, etc) For example, increasing labour costs might be offset by
growth in labour productivity. Moderate, controlled appreciation will
not, ceteris paribus, detract from foreign investment attractiveness,
though certainly a freefall of the dollar would cause concerns of a
sudden correction and detract from overall economy stability.
Persistent stability, improved image of domestic borrowers
Currently, FDI or rather the lack thereof is less influenced by the
exchange rate than it is by other factors: political risks, insufficient
legislative base, poor contract enforcement and property rights
130
125
120
115
110
105
100
95
90
85
80
Nov-00
Nov-01
Nov-02
Nov-03
Source: Goskomstat, Raiffeisen research
Figure 1.2.4 Real average labour productivity index, Dec 00 = 100
19
250
200
150
100
Average nominal wages,

$ per worker, 3mma
50
0
Jan-96
Jan-97
Jan-98
Jan-99
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Source: Goskomstat
Figure 1.2.5 Average nominal wages

16.0
14.0
12.0
10.0
8.0
6.0
4.0
2.0
0.0
-2.0
-4.0
1994
1995
1996
1997
1998
1999
2000
2001
2002
20039m
Source: CBR
Figure 1.2.6 Foreign loans and portfolio investment inflow to Russias

private sector ($bln)
7
6
5
FDI to Russia, $ bln

4
3
2
1
0
1994
1995
1996
1997
1998
1999
2000
2001
Source: CBR
Figure 1.2.7 Foreign direct investment to Russia ($bln)
2002
2003
20
protection, corruption, etc. Within this bouquet, appreciation of the

domestic currency, which potentially raises costs, takes a backseat to
broader political and legal considerations.
Turning to portfolio investments, on the debt side Russian corporate
borrowing on international markets is burgeoning. The total value of
issued corporate and bank Eurobonds has reached $13.8 billion, while
total portfolio investment and loans to domestic borrowers should
reach the level of $25 billion for 2003.
Interest rates: flat at best; external rates: all

eyes on the US
505
350
455
300
405
355
250
305
200
255
150
205
155
EMBI Russia
100
EMBI Global Composite (rhs)
50
105
55
5
Jan-01
0
Jun-01
Nov-01 Apr-02
Sep-02 Feb-03
Jul-03
Dec-03
Source: Bloomberg
Figure 1.2.8 EMBI indices performance

Following the victory march of emerging market bond prices over the
last four years, the risk of a trend reversal appears tangible. While the
markets are generally anticipating a rate rise by the US FED, as soon
as the ever low 1 per cent US interest rates are actually moved up, the
US Treasury market will immediately follow suit, pulling up global
emerging market yields as well.
So at best we expect Russias yield dynamics to remain flat, at the
current level of 6.9 per cent (Russia30) until the end of the year, though
we assign high probability to a U-shaped trend, with year-end rates
edging up into the 7+ range for Russia30. Respectively, we do not foresee
any high returns on sovereign Eurobonds, though Russias spread
contraction to UST should ensure a small positive return on sovereigns,
especially after a possible S&P upgrade of Russias debt to investment
grade. For example, if yields remain unchanged from current levels by
year-end, the gain on price for Russia30 will be just 2 per cent.
21
That said, a switch to corporate dollar-denominated debt looks

reasonable, preferably to semi-state companies. Our top pick is
Gazprom bonds, which offer the highest liquidity and attractive yields.
Among others, MTS also stands out, and it could be a good speculative
buy on rumours of the acquisition deal with Vodafone. Corporate
Eurobonds in general should enjoy spread contraction to sovereigns,
which should compensate for the likely twist in global market trends.
13
12
11
10
9
8
Russia' 30
Gazprom'13
7
6
5
Jan-02
Jul-02
Jan-03
Jul-03
Jan-04
Source: Bloomberg
Figure 1.2.9 Russia30 and Gazprom13 yields

Domestically there are two crucial points:
1. movement of the exchange rate;
2. movement of international yields.
Rouble vs. dollar dynamics on Russian FX markets again will be the
crucial factor driving domestic rate trends. Given our assumptions, we
would expect interest rates to gradually drift down for the first half of
2004, and then stabilize or perhaps even edge upward in the second half.
The first half of the year will most likely continue to witness oils at
their highs, and respectively strong external accounts, fuelling appreciation of the rouble against the dollar and pumping money onto
financial markets. Assuming that international interest rates will not
start to rise earlier than in autumn 2004, we expect domestic bond
yields to slowly move down from their current levels.
A reversal of this trend would largely depend on global rate
dynamics, as domestic rates are usually set with certain positive
22

18
16
14
12
10
8
6
UES 2
Gazprom 2
TNK 5
Alrosa 19
OFZ 45001
4
2
0
Jan-03
Feb-03
Apr-03
May-03
Jul-03
Sep-03
Oct-03
Dec-03
Feb-04
Source: MICEX, Raiffeisen research
Figure 1.2.10 Corporate vs sovereign bond yields
spreads to the Eurobond yields, a habit that seems to persist in spite of

the already lengthy period of rouble appreciation.
At the same time, supply of bonds should increase. MinFins
borrowing plans are quite extensive, and are concentrated in the
second half of the year. In particular, MinFin aims to issue several long
and sizeable benchmark OFZ issues for 3, 5 and 10 years, which will
serve as benchmarks for the rest of the market. Each issue will be
R3035 billion.
In 2004 the authorities hope to make the market larger, more diversified and volatile, and much more competitive ie to put an end to the
practice whereby the State Pension Fund and Sberbank basically
dictate new placements.
MinFin is targeting net borrowing of approximately $5 billion in 2004,
including CBR plans on selling OFZs from its own portfolio this year.
This should help absorb the swell of funds pouring into domestic
markets. In order to improve market liquidity, MinFin will limit the
share of newly issued papers in a single investors portfolio to 35 per cent.
The authorities also promised two principally new instruments. The
first is state savings bonds issued for the purpose of investing pension
contributions. However, this will materialize no earlier than the second
half of the year, as relevant legislation needs to be adjusted. In
particular, amendments would include a list of investors authorized to
purchase the bonds, such as pension and investment funds. Secondly,
OFZ futures should create a derivatives market for government rouble
23
bonds. Finally, the CBR will introduce new regulations for REPO that
would allow not only GKO/OFZs to be used for collateral, but
Eurobonds and MinFins as well.
Thus, the second half of 2004 should bring greater volatility, especially if a possible slide in oil prices puts a dent in Russias external
account performance, and also given uncertainty surrounding
domestic exchange rate and international interest rate movements.
There is a risk that the government rouble bond yield curve will shift
outwards and steepen.
Turning to investment implications, the best strategy for rouble
nominal assets continues to be staying at the short end of the curve for
sovereign bonds, though switching to sub-sovereign and corporate debt
would be an even better move. Given Russias strong economic
prospects, both these classes promise to perform well throughout the
year, and offer good options for portfolio diversification on a risk-return
basis.
One of the major risks related to the domestic securities market
(apart from the already customary political and oil-related risks)
remains excessive short-term liquidity inflows, which have no place to
go but into securities. At best this generates increased volatility, at
worst a bubble.
Fortunately for the economy, the principle of investment into real
assets is one that has been increasingly exercised by domestic banks.
Development of credit is one of the bright spots for Russias economy.
Not only is international borrowing increasingly available and popular
among domestic companies, but domestic banks are making significant
headway in developing of all sorts of lending.
The Russian banking sector: an outlook

An optimist sees an opportunity in every calamity; a pessimist sees a
calamity in every opportunity.
Winston Churchill
Despite information asymmetries and the customary emergingmarket risks, Russian banks are increasingly showing themselves as
optimists.
Four years of steady economic growth have substantially altered the
landscape of Russias banking environment. Compared to the crisisridden 1990s, a number of recent developments have set Russian
banking on a principally new trajectory, including political and
monetary stabilization, liberalization and structural reform, and
tangible improvements in Russias international status.
First and foremost, banks are becoming increasingly creditoriented. Sound public finance in 20002003 has resulted in the
24

120
100
Bank deposits, $ bln

Bank loans, $ bln
80
60
40
20
0
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Source: CBR, Raiffeisenbank research
Figure 1.2.11 Bank deposits and loans

shrinking of the governmental securities market, as lending has
become much more attractive than gambling on domestic markets.
Attracted funds (primarily deposits) are increasingly used for
financing conventional banking transactions, rather than plugging the
gaps in the state budget, as was often the case prior to the crisis.
Table 1.2.1 Russian banks: credits, assets, investments
1996 1997 1998 1999 2000 2001 2002 2003
Total assets, % GDP
Total credit to private
sector, %GDP
Total credit to private
sector, % assets
Investments into
securities, % GDP
Investments into
securities, % assets
23.2
33.9
38.8
34.9
33.4
34.9
37.8
40.8
7.3
8.6
12.8
11.5
12.3
15.4
16.9
19.6
31.6
25.3
33.1
32.9
36.7
44.0
44.6
48.2
8.2
10.5
7.2
6.7
6.2
7.1
8.5
24.1
27.0
20.5
20.0
17.8
18.8
20.8
Source: CBR, RET, Raiffeisenbank research
Broadly speaking, Russias new business environment has provoked

two key changes in bank strategies. Rapid development of the
production sector has led to improvements in the financial status of
many corporate borrowers, especially export-oriented companies,
which have traditionally been the preferred category of clients for
commercial lending. Declining credit risks associated with these
companies and their improved reputation as borrowers, coupled with
dramatically lowered international interest rates, have made their
25
borrowing on international markets not only possible, but also

affordable especially taking into account nominal rouble appreciation
since spring of 2003. This trend is most vividly demonstrated by the
surge in the level of external borrowing, as well as the active tapping of
the Eurobond market by major Russian companies and banks.
At the same time, the largest domestically operating banks are
experiencing a shift in their client base. While in the previous two
years exporters dominated the list of borrowers, banks are now giving
increasing attention to relatively smaller companies oriented towards
the domestic market.
The second innovation in banks strategies is entrance into new
market niches that previously were given scant attention, namely
retail banking and services to SMEs. Both areas offer extremely high
growth potential, though of course both also pose new challenges for
banks, in terms of adjustments in technology, regional expansion and
assessment of related risks.
Income growth and further development of the monetary sector
have led to more optimistic expectations regarding stability. Besides, in
an environment of developing financial markets, people have gradually
acquired the habit of making money work for them, at least to guard
against inflation. This has fuelled strong growth rates for retail
deposits in commercial banks, which have overtaken commercial
deposits in relative value since last year. This, in turn, benefits banks
in two major ways. First, mounting retail deposits help banks to solve
the immediate problem of securing financing, albeit at a higher cost
(interest rates on retail deposits tend to be higher). Second, they help
banks to solve their liquidity problems. The Achilles Heel of the
domestic banking system has been the substantial mismatch between
the duration of assets and liabilities, an issue often mentioned in
connection with the ubiquitous undercapitalization problem.
Table 1.2.2 Retail deposits (19972003)
Retail deposits, % of
banks assets
Retail deposits, % of GDP
1997
1998
1999
2000
2001
2002
2003
19.0
6.4
19.1
7.4
18.7
6.5
18.9
6.3
21.5
7.5
24.8
9.4
27.5
11.2
Development of the retail business is one of the ways to fill in the gap.
Four years of financial stability and rouble appreciation have
encouraged households to deposit money for longer terms. While two or
three years ago deposits for one year and longer would have been
considered a novelty in Russia, they currently make up over a third of
26

30
retail deposits, % of banks'
assets
25
retail deposits, % of GDP
20
15
10
5
0
1997
1998
1999
2000
2001
2002
2003
Figure 1.2.12 Retail deposit dynamics

47
50
45
40
35
30
25
20
15
40
33
31
19 19
17
Jan 2004
10
5
Jan 2003
23
20 18
Jan 2000
3 3
1 1 2
0
demand
deposits
1-3 months
3-6 months 6-12 months
1-3 years
more than 3
years
Figure 1.2.13 Retail deposits structure, % of total
total retail deposits. However, the devil in the detail remains the
perfectly legal option of early deposit withdrawal, which, in case of a
bank run, could lead to a serious liquidity crunch.
Against the background of solid fundamental performance, households have raised their expectations for future income, providing a
strong impetus for purchases of consumer durables and spurring
demand for real estate. Retail lending began primarily with relatively
small and short loans, mostly for household appliances. The next stage
of development was car loans, and short-term, relatively small
27
Figure 1.2.14 Loans to private sector (%GDP)
Mexico
Romania
Ukraine
Russia
Source: World Bank, Central Banks websites, Raiffeisenbank research
Kazakhstan
Argentina
Latvia
Poland
Estonia
Brazil
Hungary
Chile
Czech Republic
Italy
Belgium
Spain
France
Austria
Germany
UK
China
USA
Japan
200 187
180
160
146 146
139
140
127121
120
107 106
90
100
80 77
80
66
60
45
35 34
40
27 26 23 21
19 16 13
12 8
20
0
Portugal
consumer loans (up to 3 years and $10,000 in value). However, the key
breakthrough came with the launch of mortgage loan programmes by
major retail banks. At the moment mortgage loans are one of the most
profitable and less risky categories of lending. These loans offer
fairly short terms (up to 10 years) in comparison with international
norms as well as the highest dollar rates (1015 per cent). Risk
assessment is quite efficient, as banks require a range of supporting
documentation and borrowers generally represent the wealthiest and
most stable income cohort, who are most apt to play fairly with lenders.
Retail banking growth is not only based on fundamentals. General
financial market sentiment is such that apart from an as of yet small
corporate bond market segment, fixed income instruments can hardly
offer banks acceptable returns (negative real rates remain one of the
major impulses for banks to diversify their operations beyond financial
market operations).
Despite robust development over the past years, Russia still demonstrates lacklustre performance in terms of financial intermediation, and
particularly retail banking, according to both international standards
and in comparison with other transition economies. The ratio of loans to
GDP is roughly two to three times lower than in the other CEE countries,
while figures for retail banking are almost negligible in relative terms.
However, the prospects for the Russian banking system are bright
basically its just a matter of time. It has been less than four years since
conventional banking services started to mature, and financial
markets have been actively developing for an even shorter period.
While the banking system can boast considerable achievements in
28

120
100
80
60
40
Germany
UK
France
Croatia
Hungary
Slovakia
Poland
Czech Rep
Bulgaria
Ukraine
Russia
Romania
20
Figure 1.2.15 Retail loans (%GDP)

recent years, the memories of past failures to meet obligations still put
a brake on further expansion. Indeed, the evidence points to a considerable capital flight problem, which, though improving, still plagues
the domestic economy.
Continued economic and political stability is the main prerequisite
for robust growth in banking services overall and the retail sector in
particular. Authorities have taken the proper approach so far; gradual,
step-by-step structural reform is exactly what the system needs in
order to safeguard against possible market shocks. One of the most
essential factors on the structural side is the further development of
pension reform. Other major areas of progress include the laws on
private deposit insurance and foreign currency control liberalization,
which came into effect this year and should fuel growth and diversification in retail banking.
6.0
5.8
17.4
3.6
0.8
17.8
Trade balance
Current account balance, $ bn
Current account balance, % GDP
Gross FX reserves, $ bn
FX rate R/$1, eop

FX rate R/$1, year average
89.0
18.7
-1.7
13.8
18.3
71.6
7.1
Exports, goods, $ bn
Exports, goods % GDP
Export growth, % yoy
Export of crude oil, $ bn
Oil price, URALS, ave
Imports, goods, $ bn
Import growth, % yoy
revenues, % GDP
expenditures, % GDP
balance, % GDP
primary balance, % GDP
21.2
9.8
17.3
2.4
0.8
12.2
11.0
57.4
-39.9
74.8
23.9
-16.0
10.1
15.1
-5.0
-1.0
27.0
24.8
36.1
25.0
13.8
12.5
75.7
41.3
1.2
14.2
17.2
39.5
56.4
13.4
14.6
-1.2
2.4
20.1
31.6
62.4
10.0
251.0
9.0
17.7
2000
28.5
28.1
60.8
46.3
18.5
28.0
105.6
42.1
39.5
25.3
26.6
44.8
54.7
15.8
13.4
2.4
4.8
budget
budget
budget
budget
11.3
18.0
-6.7
-2.4
36.6
71.0
57.2
6.4
183.0
8.1
4.5
1999
Federal
Federal
Federal
Federal
84.5
23.0
19.8
-5.3
312.8
-5.2
-6.7
1998
24.8
17.4
11.0
7.4
29.8
1.4
475.1
2.0
-5.0
1997
Domestic benchmark interest rate (OFZ >3y),

%, eop
Eurobond yield (Russia30), %, eop
CPI inflation %, eop

PPI inflation %, eop
Money supply growth, M2, yoy %
GDP, % yoy
GDP $ bn
Industrial production, % yoy
Capital investment, % yoy
Table 1.2.3 Economic indicators
30.1
29.1
49.4
34.5
11.1
36.7
103.2
33.3
-2.2
24.6
22.9
53.8
-14.1
17.7
15.3
2.4
5.0
16.5
12.6
18.6
10.6
40.1
5.2
310.3
4.9
8.7
2001
31.8
31.3
46.6
29.5
8.4
48.5
107.6
30.8
4.3
29.1
23.7
61.0
3.7
20.1
18.7
1.4
3.4
13.8
9.1
15.1
17.5
32.3
4.1
349.5
3.8
3.5
2002
29.8
30.8
59.6
39.1
7.9
70.6
134.4
30.8
24.9
39.7
27.0
74.8
13.9
19.3
17.7
0.7
3.3
8.3
7.1
12.0
12.9
44.4
7.3
436.1
7.0
12.0
2003
27.0
28.5
55.8
38.6
6.5
101.8
143.6
24.2
6.9
47.4
26.5
87.8
18.0
18.5
18.0
0.5
2.3
9.0
6.5
12.0
13.0
34.3
6.0
568.6
7.5
10.0
2004f
28.0
27.5
42.4
24.3
3.5
112.6
139.0
19.9
-3.2
44.5
23.0
96.6
10.0
17.5
17.0
0.5
2.1
8.0
6.0
9.0
12.0
22.2
5.0
690.1
6.5
10.0
2005f

29
1.3
The Legal Regime and

Regulatory
Environment for
International Business
CMS Cameron McKenna
Russia is in the midst of economic and legislative reforms. Since 1990

the Russian government has put into place the statutory framework to
bring the country up to modern standards and harmonize legislation.
Although Russia does not yet have a stable and established legislative
system, this issue remains one of the key priorities of the Russian
government.
The legal structure developed during the 1990s at a rapid pace, with
significant reforms being attempted in almost every sphere of law. The
process of consolidating and rationalizing the legal framework of
Russias market economy remains ongoing with major changes anticipated in a number of key areas.
Constitutional structure
Constitution
The Constitution of the Russian Federation was adopted by the
National Referendum on 12 December 1993. The Constitution defines
the sovereign power of the Russian Federation, describes its federal
structure, governing system and the principle human rights enjoyed
by citizens of Russia. The Russian Federation is governed by a
political system modelled after many in the West. The governing
system is composed of three branches: the executive, the legislature
and the judiciary.
The Legal Regime and Regulatory Environment for International Business
31
Federal structure: local and federal government

The Russian Federation consists of 89 subjects, including regions,
ethnically-based autonomous republics, territories and the federal
cities of Moscow and St Petersburg. The Constitution granted these
subjects certain autonomy over internal economic and political affairs.
The Constitution sets out a general list of powers reserved to the
Federal authorities. Other powers are expressed as jointly exercised by
the Federal and local authorities. The regional authorities are then
allocated all other powers not specifically reserved by the Federal
Government or exercised jointly. These powers include the power to
manage municipal property, establish regional budgets, collect
regional taxes, and maintain law and order. Bilateral power-sharing
treaties between the central government and the subjects of the
Russian Federation have become an important means of defining and
clarifying the boundaries of their respective power and authority. The
Constitution gives regional bodies the authority to pass laws provided
those laws do not contradict the Constitution and existing federal laws.
Many subjects, however, have adopted their own constitutions, which
in several cases allocate powers to the regional government that are
inconsistent with the provisions of the Federal Constitution.
Executive branch and its structure

Under the Constitution, the executive branch is headed by the president,
who is elected for a four-year term. The Constitution does not provide for
a vice president. The president has the right to choose the prime
minister, with the approval of the State Duma (the lower house of the
Russian parliament). The president, upon the recommendation of the
prime minister, appoints ministers, who are responsible for the introduction of primary and secondary legislation in their respective fields.
Russias president determines the basic direction of Russias
domestic and foreign policy and represents the Russian State within
the country and in foreign affairs. The president is commander-in-chief
of the Russian armed forces; he approves defence doctrine, appoints
and removes the commanders of the armed forces and confers higher
military ranks and awards.
The president has broad authority to issue decrees and directives
that have the force of law, although the Constitution states that they
must not contradict other federal laws or the Constitution. In certain
circumstances, the president has the right to dissolve the Duma.
Parliament and the basics of the legislative process

The legislative branch of the Russian Federation is the Federal
Assembly (federalnoye sobraniye), which consists of the Federation
32
Council (sovet federatsii) (178 seats, filled by the representatives of

executive and legislative branches of power of each of the 89 federal
administrative units) and the State Duma (gosudarstvennaya duma)
(450 seats, half elected by proportional representation from party lists,
and half from single-member constituencies; members are elected by
direct popular vote to serve four-year terms). The two chambers of the
Federal Assembly possess different powers and responsibilities,
although the State Duma is the most significant.
The Federal Assembly is a permanently functioning body, in that it
is in continuous session except for a regular break between the spring
and autumn sessions. Deputies of the State Duma work full-time on
their legislative duties; they are not allowed to serve simultaneously in
local government or to hold Federal Government positions.
Each legislative chamber elects a chairman who controls the
procedure of the chamber. The chambers also form committees and
commissions to deal with particular types of issue. They prepare and
evaluate draft laws, report on draft laws to their chambers, conduct
hearings, and oversee implementation of the laws.
Draft laws may originate in either legislative chamber, or they may
be submitted by the president, the government, local legislatures, the
Supreme Court, the Constitutional Court, or the High Arbitration
Court. Draft laws are first considered in the State Duma and must pass
three readings before being passed to the Federation Council. After
adoption by a majority of the State Duma members, a draft law is
considered by the Federation Council. If a bill is rejected by the
Federation Council, a Conciliation Commission may be established,
comprising representatives of the Duma and Federation Council, to
review and amend the draft before it is presented again to the
Federation Council. The establishment of a Conciliation Commission is
the prescribed procedure to work out differences in bills that have been
considered by both chambers.
When a draft law is adopted by the Federation Council, it must be
signed into law by the president. The president has a veto, which if
exercised can be overridden by a resolution passed by two-thirds of the
members of the Duma and Federation Council.
Judicial system
The judicial system in the Russian Federation is split into three
branches: the courts of general jurisdiction with the Supreme Court at
the top, the arbitrazhniy or commercial court system with the High
Arbitrazhniy Court as the supreme body, and the Constitutional Court.
The judicial system is also divided into a federal system and a system
of local courts of the various subjects of the Russian Federation.
33
The Constitutional Court decides whether federal and local legislation and regulations comply with the Constitution. The
Constitutional Court also resolves jurisdictional disputes between
federal or local authorities, and it may interpret and clarify the
Constitution.
Criminal, civil and administrative cases involving individuals not
engaged in business activity are dealt with by the courts of general
jurisdiction. The initial stage in the system is the magistrate.
Magistrates serve each city district and rural district. The whole
system consists of the magistrates, district courts of general jurisdiction, Supreme Courts of the constituent subjects of the Russian
Federation, and the Supreme Court of the Russian Federation.
Decisions of the lower courts of general jurisdiction can be appealed
through intermediate district courts and the Supreme Courts of the
subject of the Russian Federation up to the Federal Supreme Court.
As established by the New Arbitration Procedure Code, which came
into force on 1 September 2002, economic disputes involving legal
entities, individuals engaged in business activity and disputes between
legal entities and their participants (shareholders) are dealt with by
the arbitrazhniy or commercial arbitration courts. These are sometimes referred to, rather misleadingly, as arbitration courts. The arbitrazhniy court system consists of arbitrazhniy courts of the subjects of
the Russian Federation, federal arbitrazhniy courts and the High
Arbitrazhniy Court of the Russian Federation. The High Arbitrazhniy
Court is the highest court for the resolution of economic disputes.
The Ministry of Justice administers Russias judicial system. The
Ministrys responsibilities include administrating the court system,
supervising court activity and organization, as well as performing a
number of other supervisory, administrative and systematic functions.
Law enforcement functions are performed by the Procurator
Generals Office (procuratura), which has local offices in cities and
provinces, by the Ministry of Internal Affairs and by the Federal
Security Service. The Procurators office supervises the law
enforcement agencies and investigates crimes and prosecutes
offenders. The Ministry of Internal Affairs controls all the various
police agencies and supervises prisons and the fire service. The Federal
Security Service (formerly the KGB) is responsible for counterintelligence work and investigates organized crime and terrorism.
Basics of the civil law system

Legal system and legislative subordination
The Constitutional Laws, Federal Laws and Laws of the Russian
Federation form the foundation of the legal system. Presidential
34
Decrees, Orders of the Government and decisions of various ministries

support and describe the provisions of the primary laws and, as a
matter of constitutional theory, should not contradict them.
The Russian legal system is a civil law system in the Continental
European tradition. Various Codes govern all major spheres of
business activity. The principal Codes are:
Civil Code of the Russian Federation (grazhdanskiy kodeks);
Tax Code of the Russian Federation (nalogovyi kodeks);
Custom Code of the Russian Federation (tamozhennyi kodeks);
Labour Code of the Russian Federation (trudovoi kodeks).
Civil and corporate legislation

Civil legislation of the Russian Federation is based on the Civil Code
(Parts I, II and III) (the fourth Part should be adopted soon) of the
Russian Federation of 1994. Pending adoption of Part IV of the Civil
Code, some parts of the Civil Code of the Russian Soviet Federal
Republic of 1964 and Civil Code of the USSR of 1991 remain in force.
Within the decade Russia has developed comprehensive corporate
legislation covering all major issues of corporate activity. The general
principles of corporate legislation are discussed in Chapter 4.1
Business Structures.
Tax legislation
Russia is currently in the midst of significant tax reform. In August
2000 Part II of the Tax Code was signed into law and became effective
in January 2001. Many tax regulations are in transition. The main
taxes are:
Profit Tax. Profit tax is levied on the enterprises gross profit. The
general tax rate is 24 per cent of gross profit with some exceptions.
Value Added Tax (VAT). VAT is calculated on the sales value of goods
(services, works) at a general rate of 18 per cent with certain exceptions. Imported goods are also subject to VAT.
Excise Tax. Excise tax is levied on the sale or importation of certain
goods (alcohol, tobacco, jewellery, cars, oil, gas, and other). The tax
rate varies for each product.
Land and Property Taxes. Land and property taxes are levied by the
local authorities at a rate depending on the location of the property.
Personal Income Tax. Personal income tax is calculated at a flat rate
of 13 per cent.
35
Property, currency, custom and international legislation

The Constitution gives Russian citizens general rights to own, inherit,
lease, mortgage and sell property; however, there are many gaps and
ambiguities in the legislation that implements these rights. A new
Land Code came into force on 29 October 2001 regulating the use and
ownership of municipal and industrial land. Agricultural land is specifically excluded from the jurisdiction of the Land Code and is regulated
by a separate federal law on agricultural land, which came into force on
27 January 2003. The law on agricultural land provides that agricultural land cannot be owned by foreign legal entities or individuals or
Russian legal entities if more than 50 per cent of their charter capital
is owned by foreigners.
Russia has extensive and complex currency control legislation. The
Russian currency, the rouble, is the only legal tender in Russia. There
are two types of currency operation according to the Law of the
Russian Federation On Currency Controls of 9 October 1992:
1. Current operations: includes import/export contracts with deferral
of payment for less than 90 days, loans not exceeding 180 days, and
some other transactions.
2. Capital operations: includes direct and portfolio investments,
import/export contracts with deferral of the payment for more than
90 days, loans exceeding 180 days and some other transactions.
Capital operations generally require permission from the Central
Bank of the Russian Federation (CBR). Non-residents of the Russian
Federation may have both foreign currency and rouble accounts to
service their operations in Russia.
On 15 December 2003 the President of the Russian Federation
signed the new version of the Federal Law On Currency Regulation
and Currency Control, which replaced the existing version of the law.
Most of the provisions of this law should come into effect six months
after its official publication, (ie in June 2004).
This law contains an exhaustive closed list of capital currency operations, the performance of which may be regulated by the Russian
Government or the Central Bank. Contrary to the previous situation
the law changes the main principle of Russian currency control from
everything which is not allowed is prohibited to an opposite position
of everything which is not prohibited is allowed. Instead of specific
permissions for certain types of capital operations the Law
establishes a liberalized approach to such operations (such as
mandatory reservation requirements, special accounts to conduct
capital operations etc).
The mandatory conversion requirement in relation to foreign
currency export proceeds will remain the same (a maximum level of 30
36
per cent with the right of the Central Bank to establish a lower
percentage).
Many of the currency control restrictions established by the Law are
due to be abolished as of 1 January 2007.
The main legislative act governing the customs legislation of Russia
is the Customs Code of the Russian Federation of 18 June 1993, which
was in force until 1 January 2004. It will be replaced by a new Customs
Code, which was signed into law in 2003. Russian import tariff rates
vary from 0 to 100 per cent, depending on the imported item. The tariff
rate for cars depends on the year of production of the imported car and
varies from 1.4 to 3.2 EUR per cubic centimetre of engine volume. The
import tariff rates for tobacco vary from 5 to 30 per cent. In addition to
import tariffs, VAT and selective excise tax are also applied to imports.
Import licences are also needed for certain types of goods (alcohol etc).
The Constitution states that general principles of international law
and international treaties are part of the legal system of the Russian
Federation. If Russia is a party to an international treaty that contains
provisions contradictory to the provisions of the Russian legislation,
the provisions of the international treaty prevail.
Foreign investment legislation

While the encouragement of foreign investment is a stated Russian
government priority, there have been difficulties in creating a stable,
attractive investment climate. Foreign investors concerns about the
legal system, corruption and taxation are key factors affecting foreign
investment, rather than any explicit express restrictions imposed by
the government.
Foreign investment law

The main legislative act governing the sphere of foreign investments
is the Law of the Russian Federation On Foreign Investment in
the Russian Federation of 9 July 1999 (Foreign Investment Law). The
Foreign Investment Law provides the statutory basis for the
treatment of foreign investment. The Law states that foreign
investors and investments shall be treated no less favourably than
domestic investments, with some exceptions. Such exceptions may be
introduced to protect the Russian constitutional system, the morality,
health and rights of third persons or in order to ensure state security
and defence.
Russian legislation may also introduce special rights promoting
foreign investments. The Law permits foreign investment in most
sectors of, and in all forms available in, the Russian economy: portfolios
of government securities, stocks and bonds, and direct investment in
37
new businesses, in the acquisition of existing Russian-owned enterprises, in joint ventures, etc. Foreign investors are protected against
nationalization or expropriation unless this is provided by the federal
law of the Russian Federation. In such cases, foreign investors are
entitled to receive compensation for the investment and other losses.
Restrictions on foreign investment

Currently, there are relatively few explicit restrictions on foreign direct
investment. Foreign ownership in the natural gas monopoly, Gazprom,
is limited to 14 per cent. Legislation limits foreign investment in the
electric power company, Unified Energy Systems (UES), to 25 per cent.
The Russian Law On Insurance of 27 November 1992 established a
ceiling of 15 per cent on the total amount of foreign investment in the
insurance industry of the Russian Federation as a percentage of the
total insurance capital in Russia. Insurance companies in which
foreigners own more than 49 per cent of the Charter Capital may not
engage in certain types of insurance business, including life assurance
business.
The CBR has the right to use reciprocity as a criteria to specify the
types of business that foreign banks may be licensed to operate in
Russia, and is permitted to impose a ceiling on the total amount of
foreign bank capital as a percentage of the total bank capital in Russia.
At present, foreign banks share of the total capital bank is well below
the 12 per cent ceiling set by the CBR.
International treaties
Russia is party to a number of international treaties, which are aimed
at the protection of foreign investments:
Bilateral investment treaties: these treaties generally guarantee
non-discriminatory treatment for foreign investments and investors
in Russia, provide for compensation to be paid for expropriation or
nationalization, and allow disputes to be referred to international
arbitration. Russia holds such agreements with the United
Kingdom, Germany, Italy, Spain, the Netherlands, Finland, France,
Switzerland and others. The treaty entered into with the United
States is waiting to be ratified.
Treaties for the avoidance of double taxation: these treaties generally
provide relief from double taxation, guarantee non-discriminatory
tax treatment and provide for co-operation between the tax authorities of the respective signatory countries. Russia has such agreements with Austria, the United Kingdom, Greece, Denmark,
Ireland, Spain, Italy, Canada, Cyprus, the Netherlands, the United
States, Germany, France, Switzerland and many other countries.
1.4
Latest Developments in
the Foreign Investment
Climate
Andrew B Somers, President, American
Chamber of Commerce in Russia
There are several key factors with respect to judging the investment
climate in Russia, and the net effect in looking at these factors is
positive.
The first factor is macroeconomic indicators. Russia has demonstrated a remarkable macroeconomic performance in the last few years
in terms of its GDP growth, continued budget surplus, creation of a
reserve fund in the event of a drop in world oil prices, accumulation of
foreign exchange reserves by the Central Bank, and very sound fiscal
policies. The fact that tax collection has increased significantly since
Russia introduced a 13 per cent flat income tax is of extreme importance. All of these indicators remain very positive in the outlook for
2004.
The second very telling factor is the rapidly growing number of highlevel American executives coming to Russia with either business plans
for investment or serious intent to look at the options. This is essentially a final step before pulling the trigger on significant investments.
These visits strongly indicate that the psychological hurdle that previously prevented American business leaders from looking at Russia as
an investment destination has been removed. In many instances, these
companies are pursuing a two-stage plan first to manufacture for the
Russian domestic market, and later to upgrade the technology and
export abroad to a different niche of customers. This tells us that
Russia is now on the map, along with China, India and Brazil; and
among this list of countries, many CEOs have rated Russia as first.
The third factor in judging the investment climate is the
governments commitment to continued reform. We think that the
39
streamlining of the government that took place in the spring of 2004,

reduction of the number of ministers by almost half and the number of
deputy prime ministers from six to one, as well as the merging of functions which logically belong together, all point to the presidents
commitment in his second term to drive the reform effort deeper and
broader than before. One such positive example is the alignment of the
State Customs Committee under the Economic Development and
Trade Ministry. This is especially interesting because customs collects
42 per cent of all budget revenues, and thus could have easily reported
to the Finance Ministry. But the State Customs Committee leadership
has stressed the importance of stimulating business as the agencys
main priority, and this aspect of the mission should be enhanced by the
structural connection to the Economic Development and Trade
Ministry, whose basic mission is to increase GDP and facilitate
business and investment.
The fourth important positive factor is progress in the WTO
accession process. In the spring of 2004, Russia completed the essentials of its negotiations with the European Union, and concluded an
agreement in principle with this very important trading partner.
Negotiations with the United States continue apace, and the gaps
between the two sides are slowly but surely closing. Although areas
like access of foreign companies to Russias financial and insurance
sectors and tariffs for airplanes remain important obstacles to
reaching an agreement, the most critical issue is protection of intellectual property rights. Recently, Russia has demonstrated some
progress in this area as well, and we are betting that the last obstacles
to WTO accession will be eliminated by the end of 2005, paving the way
to a rules-based system and Russias greater openness to international
trade and investment.
The fifth positive factor is continuous support from the US and
Russian governments for the bilateral processes that have been
initiated by Presidents Bush and Putin to seek and act upon the recommendations of the private sector. The Russian American Business
Dialogue (RABD) is such a public-private sector effort, and AmCham
and the Russian Union of Industrialists and Entrepreneurs (RSPP)
are its lead organizations. At the top of its agenda are recommendations to the two governments for improvements in the area of intellectual property rights protection, establishment of a business group to
monitor the implementation of the new Customs Code that went into
effect on 1 January 2004, and improvement of the environment for
small business. Specifically on the latter point, we are asking the
Russian government to increase the revenue level defining small
business and thus expand the number of companies eligible for tax
breaks and relieved administrative burdens as provided by the
recently adopted legislation on small business. Another example of
40
such public-private sector efforts contributing to the improvement of

the investment climate in Russia is the US-Russia Commercial Energy
Dialogue (CED). Within the framework of CED, Russian and American
energy companies make recommendations to the two governments to
improve the environment, and this initiative is beginning to show some
successes.
Obviously, problems still exist. There are still cases when foreign
businesses find themselves under pressure from their Russian
partners trying to take over the ownership of a joint venture once it has
proved to be profitable. In some of those instances, local administrations seem to have a relationship with the private interests that are
trying to squeeze out the foreign business. Naturally, we are concerned
about such situations and when they come to our attention, we
intervene to get a hearing with the appropriate authorities or with the
Russian private companies involved. We are very often successful in
resolving matters, and this is encouraging. We do not lobby on behalf of
individual companies, but when there is an issue affecting the
investment climate, we consider it part of our mission to intervene at
the request of our members. One very notable example of the Chamber
taking an active role is the situation with Sakhalin-3, when the
Russian government annulled the result of the 1993 tender that
awarded the rights to develop the oil fields to two American oil majors.
We view this issue as confined neither to these two companies, nor to
the energy sector only the issue at stake is property rights, and we
have urged the Russian government to reach a solution that would not
be threatening this very basic principle.
In this context, the effort by the Russian business community to
initiate an alternative dispute resolution process is very promising.
The RSPP has created a Business Ethics Commission to resolve
disputes between businesses outside the legal system because this
system is still very rudimentary in terms of property and investment
rights. Essentially, it is a two-step process. When a company registers a
complaint with the Commission, the Commission contacts the other
company involved and suggests informal and private mediation to help
the two sides find a compromise solution. If that doesnt work, then the
complaining party has an option to ask for arbitration. The
Commission has a list of about 70 qualified arbitrators, and each party
selects an arbitrator from this list. Then, both arbitrators select the
third neutral member of the arbitration panel. Following an
informal arbitration hearing by this panel, both parties are committed
to following the findings. The ruling does not have the force of law but
it has the force of moral imperative. The process is very new but it
seems to be working: in less than one year the Commission has had a
few cases and decisions have been taken. AmCham has signed a
protocol with the RSPP to support this effort to resolve business
41
disputes in a civil manner. We view this as an effort from the Russian

private sector to improve the environment.
On balance, we believe the investment climate in Russia continues
to improve. The market continues to expand, and certainly American
companies continue to have very successful results. 2002 and 2003
were banner years for the American companies in terms of revenues,
profit margins and growth in market share. All prospects are very
positive for 2004 and we think Russia is a very good investment bet for
most sectors of the economy.
1.5
The Russian Investment

Climate
Branan
Introduction and summary

The Russian investment climate has undergone spectacular transformation during the past decade and continues to offer new and
attractive opportunities. Following the debt crisis in 1998 Russias
economic and political stability improved considerably and a combination of key structural reforms, solid foreign policy and high natural
resource prices have propelled Russia to a new level of global competitiveness. Moreover, with the emergence of a viable local services sector
together with strengthening consumer confidence, the country is
slowly moving away from a natural resource dependent economy to a
more diversified competitive market.
Several key risks remain however, which impact on the overall
attractiveness of the Russian market. On the reform agenda Russia is
yet to create a credible banking system, liberalize natural gas prices,
and complete the restructuring of its electricity sector. Politically the
country has found itself in the midst of several corporate quarrels,
which continue to fuel negative investor sentiment and affect the
Russian equity and debt markets. Although not as prevalent as in the
early 1990s, local crime remains a concern in light of several recent
assassinations. Law enforcement continues to be under a shadow of
bureaucracy and corruption. Russia has come a long way since the
dissolution of the Soviet Bloc in the late 1980s and has a long road
ahead as it gradually converges with the economic competitiveness of
its business partners around the world.
Economy
The Russian economy has been successful at maintaining its
resilience, which in large part, is attributed to strong GDP growth,
43
high natural resource prices, and diversification of its domestic

demand components. Despite recent speculation around the banking
sector and ongoing legal battles between the government and Russian
oil major Yukos, the countrys macroeconomic picture remains robust.
The countrys GDP expanded 7.4 per cent year-on-year in the first
half of 2004. The government has also upgraded its year-end economic
growth target to 6.9 per cent on the back of healthy export figures and
positive outlook on the external markets. Construction, Transport
and Retail Trade growth rates rose 14.2 per cent, 7.4 per cent, and
11.1 per cent, respectively. Russias economics minister, German Gref,
has set the GDP target for 2005 at 6.3 per cent. High oil prices
continue to support domestic income growth via net exports, in
addition to increasing consumption and investment. Russias 1998
financial downturn brought about the low point of foreign investor
confidence in Russia. Nevertheless, foreign investments in Russia are
slowly on the rebound. Foreign investments include loans, trade
credits, foreign direct investments (FDIs) and foreign portfolio investments (FPIs). Foreign direct investment has expanded impressively
in the past three years going from $4 billion in 2002 to $7 billion in
2003 and is expected to reach $8 billion in 2004. Compared with other
emerging markets in terms of FDI/GDP and FDI per capita, Russia
ranks near the bottom, which doesnt seem to reflect its rapid
economic recovery. Although Russias FDI still remains quite modest
compared to other countries, the recent positive trend reflects
Russias appeal to global businesses as a viable and lucrative place to
invest.
Diversification away from the natural resource sector has recently
been the major theme for the Russian economy and is a key to further
economic growth. Total demand has been shifting toward the consumer
and services sector where strong capital investment in Russia has
boosted productivity and enhanced competitiveness. Going forward,
however, the non-resource industrial sectors are not likely to grow as
quickly as the output in the consumer and services categories,
including telecoms, media, finance, transportation, etc. Nor are nonresource industries likely to expand faster than the extractive industries (fuel and metals) should commodity prices continue to rise or
remain at high levels. Turning again to the gross domestic product
components, the trend of stronger consumer-services growth is
evident. In 2003, services comprised close to 62 per cent of the Russian
GDP, and growth in the market-based service output exceeded growth
in the goods sectors, similar to 2002 (the first time in Russias history)
(see Figure 1.5.1). The pricing power of services providers will remain
strong, driven by domestic consumer demand.
44

12%
GDP
Goods
10%
Services
8%
6%
4%
2%
0%
1999
2000
2001
2002
2003
Source: Goskomstat
Figure 1.5.1 GDP growth rates
Other economic indicators re-emphasize the emergence of the

consumer-services trend:
Aggregate corporate profits have been substantially higher climbing
49.4 per cent in the JanuaryMay period of 2004. Although one of
the reasons is a lower tax rate, which created better incentives to
report income, the decompositions of the growth rate shows that
consumer-driven sector profits contributed the most to the final
figure. During the second quarter of 2004 communications, retail
trade, and transportation led the growth, with 75 per cent, 34 per
cent and 43 per cent, respectively.
Services Purchasing Managers Index (SPM) a single-figure
dissemination index compiled by the Moscow Narodny Bank
continues to stay above 50 (note: 50 is the threshold between growth
and contraction). July 2004 marked another month of strong
expansion as the SPM posted a 57.9 figure. Local services providers
confirm higher future business confidence in the sector in response
to growing demand and disposable income.
Another indication of higher services demand is the relatively
higher price inflation recorded in the consumer-services sector. Price
growth for services was 16.8 per cent year-on-year in July 2004,
higher than the overall inflation figure of 10.4 per cent for the same
period (see Table 1.5.1).
Although the trend toward a more diversified economy is real and
noticeable, the heavy reliance on the extractive sector will continue to
45
Table 1.5.1 CPI inflation y-o-y (July 04)
Total
Foods
Non-foods
Services
July 04
(%)
June 04
(%)
July 03
(%)
10.4
9.5
8.1
16.8
10.1
8.8
7.9
17.4
13.9
11.0
9.4
31.0
Source: IntelliNews
hold back many investors. Fitch ratings agency, which reiterated its
BB+ mark in August 2004, said its unlikely Russia will obtain a second
investment-grade rating by the end of 2004 citing two main reasons: 1)
ongoing speculation around the Yukos case, which raised questions
about the assessment of property rights in Russia, and 2) market
dependence on the oil and gas sectors. Moodys Investors Service
upgraded Russias status to the high-grade category in October 2004
and remains the only rating agency to assign Russia an investment
grade. Yury Lopatinsky, head of First Mercantile Capital Partners in
Moscow, expressed similar concerns: High oil prices have had an inflationary effect on consumer product prices and real-estate, as political
uncertainty has hampered longer term domestic investment necessary
for economic diversification.
Higher corporate profits, emergence of a strong services sector, and
soaring oil prices have all contributed to the expansion of Russias
disposable income base. Real income grew 9.8 per cent year-on-year in
the 1H04 and real wages climbed 14.1 per cent in the same period.
Consumption will continue to be supported by strong trends in
domestic income and, moreover, compounded by the rising ratio of
disposable income to personal income. With a 13 per cent income tax
rate, the lowest in Europe, and relatively low food and housing costs,
Russias emerging middle class has high ratio of disposable income to
personal income, especially in major cities like Moscow and St.
Petersburg. For the full year 2003, real disposable income grew faster
than GDP. On average, Moscow and St. Petersburg consumers have
close to 25 times more purchasing power than the rest of the country,
which suggests that much of the future consumer demand growth will
also come from the regional convergence.
The strong growth in Russias financial reserves has largely ensured
that any short- to medium-term balance-of-payments weakness would
be manageable. The country accumulated over $89 billion in gold and
foreign currency reserves through August 2004, compared to less than
$6 billion that the government held in early 1998. These reserves are
46
enough to service debt payments for several years even if oil prices
decline significantly. Russias foreign debt fell from 64 per cent of GDP
in 2000 to just 28 per cent of GDP in 2003. Moreover, the government
set up a stabilization fund in early 2004 with the purpose of hedging
against possible future budget deficits. Revenues from oil and gas
exports during periods of high energy prices will go into this fund and
will cover the budget deficit during times of low energy prices. In the
period between January and July 2004 Russia posted a budget surplus
of $9.8 billion with 59 per cent of revenues coming from taxes and 34
per cent from customs. The stabilization fund grew to around $9.2
billion.
Both the European Bank of Reconstruction and Development
(EBRD) and the International Finance Corporation (IFC) have made
strong investment pledges to Russia and are optimistic on the
investment climate overall. Some of EBRDs key objectives in Russia
include: the development and practical implementation of the
Corporate Governance Code; attraction of major international
strategic investors; and the restructuring of the natural monopolies.
With over 10 years of work experience in Russia, the EBRD has
provided project financing for banks, industries, Russian companies
and foreign strategic investors, both new ventures and investments in
existing companies. For 2004, EBRD forecasts more than $1.5 billion in
investments for Russia, with focus on the communications, transportation and energy sectors. The IFC has also made newly-pledged
investments in Russia during its FY2003 in excess of $616 million, a 65
per cent increase over the previous year. Reflecting on its commitment
to Russia, the IFC has grown geographically, investing across Russia in
a variety of sectors, including infrastructure, media, general manufacturing and services, and financial services. IFC is also a leading
investor in the IT sector and extended nearly $20 million to Russian IT
companies in 2003. For 2004, IFC made a similar investment
commitment of around $0.5 billion.
Capital flight continues to hamper the Russian economy despite
falling in recent years and even showing a net inflow in 2003. Russias
finance ministry estimated that the net capital outflow from the
country may reach $8.5 billion by the end of 2004. The main reason for
this sudden shift toward capital outflow can be explained by the overall
negative sentiment throughout the emerging markets marked by the
recent downturn in China plus the speculation around the ongoing
Yukos affair. However, despite the Yukos affair, investors remain interested in participating in joint work with other Russian oil companies,
such as Lukoil. According to German Gref, Russia will experience net
capital outflows through 2005. The accuracy of the capital flight in
Russia though is questionable given the existence of the grey market,
which could substantially increase or decrease the actual capital flows.
47
Structural reforms
Banking sector
One of the most anticipated structural reforms on the agenda today is
the banking reform. Russia is currently dominated by two or three
government-backed banks (Sberbank has a virtual monopoly
attracting close to 63 per cent of total retail deposits), which can accommodate depositors and hundreds of smaller banks that have a history
of liquidity problems, inefficiency and murky transactions. Guta Bank
fell victim to a liquidity crunch and was forced to shut down most of its
branches in the summer of 2004. Even the large business consortium
Alfa Group saw thousands of worried depositors make a run on its Alfa
Bank accounts on the back of financial sector jitters. The government
did stabilize the situation by purchasing a controlling stake in Guta
Bank through Vneshtorgbank and calming the public by injecting
extra liquidity into the market. Although the situation did not develop
into a widespread banking crisis, it did underscore the need to move
forward urgently with the financial sector reform.
With deposit insurance and foreign exchange liberalization laws
passed, Russias central bank is implementing the laws with various
decrees and measures. In the banking sector, it prepares to revoke
licences of banks that do not meet the credit standards required for the
deposit insurance system. However, it has recently eased the criteria of
qualification for the deposit insurance structure by dropping eight of
the 16 entrance criteria and softening others. Sberbank, which always
enjoyed a government backing for its deposits, was scheduled to lose
the guarantees on new deposits in October 2004 and will completely be
void of them by 2007. This would open up Russias banking sector for
competition and growth. Later on, credit bureaux will be created by the
Association of Russian Banks, which is pursuant of the Credit Bureau
Bill passed in the legislature. The association aims to create the first
national credit bureau by the end of 2004.
The Russian banking sector will encounter more turbulence going
forward as smaller illiquid banks get filtered out of the system and the
broader financial sector reform unravels. The bigger and more stable
banks will only win from the transition period attracting a larger
volume of depositors and revamping their organizational structures.
According to Tim McCarthy, Chief Investment Officer at Troika Dialog
Asset Management, with over $500 million invested in Russian portfolio securities, The Russian banking system will undergo significant
reform during the next two years. Already, the effect of a lower tax rate
has legitimized many businesses, stimulating growth of bank deposits.
The recent laws passed on land reform, mortgages and securitization
will greatly expand the role of banks in the Russian economy. Real
48
estate is already privately owned and Russian corporations and individuals are relatively under-leveraged. The consumer debt to GDP and
mortgage debt to GDP ratios are both less then 1 per cent in Russia,
while these ratios are 19 per cent and 55 per cent respectively in the US.
So, one can see that broad money supply expansion from the private
sector is likely to fuel economic growth in the foreseeable future.
Energy
The restructuring of the energy industry has become a major theme in
assessing the overall development in Russian economic competitiveness. While both the natural gas and the utilities sectors remain
under state control (Unified Energy Systems [UES]; Gazprom), the
electricity reform has made considerable progress in moving toward a
liberalized network.
The restructuring of Russias main electricity group, UES, has won
huge support in the West but proved to be a complex and sensitive
issue at home. UES is an energy holding company with stakes in 251
subsidiaries, which own stakes in the national transmission grid,
separate generation companies, and vertically integrated
generation/transmission/distribution companies. The restructuring of
the group includes unbundling, pro rata spin-offs, and privatization of
its subsidiaries, which would lead to an efficient, transparent and more
competitive electricity sector. The direction and the pace of the restructuring can be defined and forecast based on two different views of the
parties who would benefit from the reform:
Oligarch driven The influence and reach of the wealthy minority in
Russia would remain the dominant force in shaping the restructuring. Since most oligarchs are owners of local industrial groups
whose business operations are tied to exports, they are interested in
securing a steady supply of cheap energy to operate their factories.
Therefore, their unique business interests run contrary to the objectives of the UES restructuring.
Revenue driven Since the ultimate effect of the reform should
drive up energy prices, the managers whose compensation would be
tied to the companys overall revenue stream would find it in their
interest to support the reform. However, most of the managers own
very little stock in the company and a stock option plan, which has
been considered in the past, has not been implemented yet.
One of the main positive aspects of the restructuring is that unlike
other state-owned energy companies where management opposes
privatization and reform (Chinas State Power Company, Koreas
Kepco, and Brazils Eletrobras), UESs management is actually
pioneering and sponsoring the restructuring.
49
Other reforms
Several other important issues remain on the reform agenda including
the following:
Liberalization of the natural gas sector. Russian domestic gas prices
remain at deep discounts compared to the West, and lack of privatization in the state-owned Gazprom limits investments to modernize
its network. Currently the state owns 37 per cent in the gas giant
and plans to increase its stake to 51 per cent, thereby hampering
any hope for privatization in the near future. The accession into the
WTO also depends on the pace of the natural gas sector reform.
Pension system reform. The government has passed a law that
would ultimately transform the Russian pension scheme from a
defined benefit to a defined contribution. The new structure is
comprised of three layers: 1) notional defined contribution (NDC)
pay-as-you-go pension plan, 2) mandatory funded second support
trust, and 3) a benefit that will secure the distributional objectives of
the pension system. The aim of the new structure is to reduce the
complexity of the pension payment system through a simple benefit
formula and transparent eligibility requirements. However recently,
despite the new provision, the government appeared reluctant to
give up control over the populations pension savings and transfer
them to the private sector.
Politics
On the political front Russia has made strong steps forward to
becoming a more integrated member of the global community and
improved its image and integrity abroad. With the arrival of Vladimir
Putin to the presidential post the administration made it clear that it
intends to lead a more diplomatic and yielding foreign policy for Russia
in the world and that it intends to do everything in its power to attract
foreign direct investment and secure a viable trade system with the
West and the East. After securing an easy victory for his second term,
Putin increased his rhetoric on investment, economic development and
social responsibility.
President Putin made an effort to narrow the gap between Russia
and the West in terms of:
Trade Putin has signed a decree to form a free trade channel in the
Commonwealth of Independent States (CIS), thereby facilitating a
more efficient and profitable trade network between Belarus,
Ukraine, Kazakhstan and Russia. The move is an important one,
since many of the former Soviet republics have also actively sought
50
business partnerships with Europe. Germany still remains one of

the leading trade partners in terms of total volume, accounting for
more than 10 per cent of Russias foreign trade and close to 20 per
cent of total capital invested. In 2003, the turnover between Russia
and Germany totaled $18 billion.
Convergence with Europe Putin has made an effort to host several
milestone European conferences where the Russian president solidified business contracts for Russian companies and discussed
bilateral cooperation in the area of trade and security.
Global security Russia is playing an active role in the global fight
against terrorism. With its main partner, the United States, Russia
engages in the exchange of pertinent information to limit the escalation of world terrorism and illegal arms distribution.
Overall image Russia has found a new face abroad, with
foreigners perception shifting toward a more positive outlook on the
country and the investment opportunities it can offer. President
Putin is viewed as proactive leader with a pro-reform agenda.
Becoming a full pledged member of the World Trade Organization
(WTO) has also been a key aim of the current Russian administration.
Although the president was able secure much needed support from the
European Union, no definite date has been set for the accession.
According to the Ministry of Economic Development and Trade, Russia
is losing close to $2.5 billion each year by not having access to the trade
privileges granted to WTO members. The ministry hopes to win the
backing of the world community to join by 2006.
On the domestic front, the political situation has become more
choppy in the past two years as the government moves to limit the
power of so-called oligarchs who managed to accumulate substantial
wealth during the privatization era. Yukos has been in the news for
quite some time, as the tax ministry claimed that Russias largest oil
company failed to pay billions of dollars in taxes and engaged in questionable activities when expanding its empire. While the speculation
around the judicial proceedings will continue to add a degree of uncertainty for the Russian financial markets, most of the negative news
have already been priced in and should not impinge on broad economic
growth prospects.
The Yukos case does set a precedent though and the possibility does
exist that the current administration may engage in further legal
attacks on oligarchs, yet it should not trigger a wider-scale property
rights reassessment or re-nationalization of state assets.
51
Law
As Russia transforms itself into a solid market-based economy and
continues on the structural reform track it will need to further develop a
law-based economy and strengthen the institutions involved. Most of the
recent economic and political successes have been, on many occasions,
shadowed by assassinations and blatant corruption in the law enforcing
agencies. If the goal of the Putin administration is to present Russia as a
secure and profitable place to do business, the government will need to
seriously address the issues stated above. Summer 2004 was marked by
the killing of the chief Russian Forbes editor, an American-born Paul
Khlebnikov, whose work included an infamous article on Russias 100
richest people. Other similar unsolved assassinations have been a
common occurrence in the last decade, which considerably raises
Russias business risk for foreigners as well as for the locals. The legal
code in itself is contradictory, cumbersome and unpredictable. Lack of
sufficient compensation of judicial and law enforcement officials opens
up the door for various inefficiencies in the work process and corruption.
The corporate sector is directly impacted by corruption as well, since
the existence of the grey market diverts the flow of capital from the
necessary investment channels. Small- to medium-size businesses lose
out the most due to corruption, since they dont have enough reach and
influence to protect themselves from fraudulent harassment. Small businesses are estimated to lose close to $2 billion dollars from corruption.
The Russian government has recently introduced several key
measures to address the issues stated above:
Compensation increases have been implemented for state officials
in an effort to provide a level of income sufficient enough to disincentivize taking bribes. Although the move is in the right direction,
the salary levels for government employees remain way below the
corporate sector and it doesnt prevent those officials who engaged
in corruption in the past from doing it again.
The anticorruption committee was formed, which is responsible for
passing appropriate legislature to improve the honesty and transparency of the Russian regulating and controlling bodies. A law has
already been passed that prevents authorities from halting any
enterprises operations without a court order.
Corporate governance
The viability of doing business in Russia is in big part dependant on
the presence of a well-defined process to protect shareholder and
investor rights. Corporate governance emerged as the major theme in
52
the post-debt crisis of 1998 and will continue to play a major role in the
development of the Russian economy. Corporate governance, transparency and disclosure improved considerably in the last few years
especially at Russian bellwether and blue-chip companies.
Russias history of poor corporate governance dates back to the Mass
Privatization Programme (MPP) initiated in 1992. While the MPP was
meant to distribute ownership equally, the Russian government made
strategic exceptions for industries like defence, natural resources, utilities, and telecommunications. The industries mentioned were privatized partially, remaining under the control of the state. A large portion
of the shares not held by the government was made non-public and
allocated to company managers and employees. Following the privatization, which partitioned huge stakes of state property to a few
industry insiders at deep discounts, the business climate has become
predisposed to transfer pricing, asset stripping and various abuses of
minority shareholders. Most of the time the shareholder structure was
unknown and the controlling group exercised great power to benefit
only themselves. Recently the situation turned for the better, as more
and more companies began to follow the internationally accepted
accounting standards for their disclosure, increased transparency, and
put in mechanisms to prevent transfer pricing. The Institute of
Corporate Law and Corporate Governance (ICLG) was created in 2000,
which aimed to improve corporate governance practices in Russia. The
agency now performs regular reviews of Russias biggest companies
and assigns a rating that tracks their corporate governance development (see Table 1.5.2).
Conclusion
While several key risks remain, the Russian investment climate has
become more competitive, more accessible to foreign businesses, and
more diversified. Strong recent economic growth is sustainable, in the
near-to-medium term, given high natural resource prices and an
emerging consumer-services sector. FDI should continue to grow as
more foreign companies enter the Russian market and invest into local
businesses. Based on economic ministry forecasts, capital outflow will
remain an issue at least in the medium term, in large part caused by
jitters over the Yukos case and instability in the local financial sector.
However, the true net capital flow figure may vary considerably due to
the existence of a grey market.
Structural reforms will underpin further economic growth and
convince the global community that Russia is committed to building a
secure market-oriented environment. The banking reform is underway
as illiquid and less transparent banks get filtered out and more secure
VimpelCom
Norilsk Nickel
North-West Telecom
RAO UES
Lenenergo
Rostelecom
MGTS
Gazprom
Aeroflot
Volga Telecom
Lukoil
Kusbassenergo
Sibneft
Samaraenergo
Yukos
Tatneft
Tyumen Oil Company
Irkutskenergo
Slavneft-Megionneftegaz
Surgutneftegas
Severstal
Bashkirenergo
GAZ
Rosneft
Avtovaz
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
Source: ICLG
Company
Rank
86.6
72.4
72.2
70.3
67.0
64.9
62.9
62.3
61.7
60.8
60.0
59.2
58.9
57.9
56.3
54.4
52.7
52.2
51.6
51.3
49.3
48.9
46.2
44.3
43.5
4Q03
(% of maximum)
Table 1.5.2 Corporate governance rankings
3.0
10.4
11.1
7.8
3.2
7.5
15.2
5.2
4.8
36.0
10.3
0.7
5.8
3.2
9.6
17.7
2.8
5.3
2.3
2.1
2.8
9.8
1.8
33.4
3.1
Change (%)
(since 4Q02)
84.1
65.6
65.0
65.2
64.9
60.4
54.6
59.2
58.9
44.7
54.4
59.6
62.5
56.1
62.3
46.2
54.2
55.1
52.8
52.4
50.7
54.2
45.4
33.2
44.9
4Q02
(% of maximum)
1.8
19.6
0.4
19.4
37.2
17.2
9.5
0.8
25.3
2.4
48.4
4.7
13.6
5.1
1.8
3.4
13.2
9.5
Change (%)
(since 2Q00)
82.1
44.2
62.1
57.4
68.4
61.5
52.8
52.3
53.8
na
49.7
59.1
49.9
na
45.4
55.8
na
68.4
na
43.8
50.9
na
44.6
na
na
2000
(% of maximum)

53
54
financial institutions are granted licences from the Central Bank. The
deposit insurance law was a landmark decree passed to pave the way
for the financial sector reform. The energy sector has also attracted
plenty of attention with the restructuring of the worlds largest utility
group, Unified Energy Systems. It is yet unclear how fast and where
the reform will go given the existence of opposing interests influencing
the process.
The Putin administration has no doubt created a more stable
political environment than the one witnessed during the Boris Yeltsin
years, and advocated a pro-reform and pro-investment agenda.
Corporate governance will continue to play a key role in the overall
assessment of Russian companies, specifically their transparency and
managerial fairness.
The attractiveness of the Russian market will remain contingent on
its ability to continue bold structural reforms, advocate higher standards of corporate governance and diversify its economic output.
1.6
Russian Country Risk:

Clouding Future
Prospects for Russian
Corporates
Elena Anankina and Robert E Richards,
Standard & Poors
Despite the improving sovereign ratings of The Russian Federation,

country risks still weigh on the credit quality of Russian corporate
entities. Risks inherent from operating in The Russian Federation
(foreign currency BB+/Stable/B; local currency BBB-/Stable/A-3) have
long been factored into the credit ratings on Russian corporates.
Despite improving sovereign credit quality, however, corporate entities
in the region remain subject to the uncertain implementation of legislation and regulations, a centralized political regime where decisions
are driven by individuals rather than institutions with wellestablished purposes, a concentrated economic structure with a lack of
diversification, and a weak domestic banking system. These factors are
tempered, however, by current incentives for transparency supported
by strong international demand for emerging market debt.
Russias weak institutional structure remains the key constraint on
corporate credit quality in the country because it translates into an
unpredictable regulatory, legal, and corporate governance environment and leads to the lack of a solid base for improving the
countrys economic structure. At the moment, it is unclear whether
Russia is poised for progress or will regress into an environment where
businesses operate under the threat of political intrigues, personal
power plays, and ineffective or parasitic bureaucrats.
Standard & Poors methodology for assessing corporate credit
quality considers country risk a particularly important element of
credit risk in emerging markets. This methodology distinguishes
between the risk of sovereign default or direct interference such as
56
currency controls which are captured by a countrys sovereign credit

rating, and other indirect risks endemic to a company operating in a
particular country (see Local Currency Rating Criteria Update).
Endemic country risks are important considerations when rating
Russia-based corporations, as important reforms and diversification of
the economy lag behind the rapid fiscal improvement achieved by the
Russian Federation itself.
On 27 January 2004, Standard & Poors Ratings Services raised its
long-term foreign currency sovereign credit rating on the Russian
Federation to BB+ from BB, and its local currency sovereign credit
ratings to BBB-/A-3 from BB+/B. The upgrade was driven by the
improved fiscal and liquidity position of the Russian government. This
reduces the probability of the governments default and a reoccurrence
of the turmoil and stress that such events cause for the corporate sector.
Russias regulatory, legal, and corporate governance environments
remain weak, however, as recently highlighted by the effective reversal
of the acquisition of OAO Siberian Oil Co. (Sibneft; B+/Watch Dev/) by
another oil company, OAO NK Yukos (BB-/Watch Neg/). On balance,
such risks remain undiminished in light of recent evidence that
Russian companies and their investors can be subjected to government
pressure through selective implementation of regulations and legislation that is either politically motivated or triggered by competing
business groups. This, in turn, threatens to negatively affect the
investment climate, corporate governance environment, property
rights protection, and incentives to transparency.
So far, there has been no significant increase in capital outflows
from Russia as a result of uncertainty about principles and practices
upon which the Russian government will be based after the March
2004 presidential election. These political and institutional risks are
being counterbalanced in the short term by strong international
demand for emerging market debt and Russias robust macroeconomic
and fiscal performance on the back of high oil prices. For individual
firms, access to international funding should be an incentive to
improve transparency, disclosure, and governance practices toward
international standards. Whether Russian companies will continue to
enjoy good access to the international financial markets and a healthy
operating environment over the longer term, however, depends on the
pace and effectiveness of economic, institutional, and legal reforms
after the presidential election.
Credit strengthening of Russian corporates slows

Standard & Poors currently rates 31 Russian companies on its global
scale. The long-term ratings on these companies range from CCC+ to
BB+.
Russian Country Risk: Clouding Future Prospects for Russian Corporates
57
Developing outlook and CW Developing
Negative outlook and CW Negative
Stable
Positive outlook and CW Positive
6
5
4
3
2
1
0
CCC+
B-
B+
BB-
BB
BB+
Figure 1.6.1 Outlook distribution of Russian corporate ratings on

13 May 2003
Developing outlook and

CW Developing
9
8
7
Negative outlook and

CW Negative
Stable
Positive outlook and

CW Positive
4
3
2
1
0
CCC+
B-
B+
BB-
BB
BB+
Figure 1.6.2 Outlook distribution of Russian corporate ratings on

4 March 2004
Since the 1998 financial crisis, the credit quality of Russian companies
has improved steadily and significantly. During 2003 and January to
February of 2004, there were 14 upgrades and one downgrade,
although the majority of long-term ratings remain in the B category.
The structure of outlooks and CreditWatch placements has became less
positive, however, indicating that the remarkably strong positive trend of
58
the past few years is slowing down. One year ago, all the corporate
outlooks, with one single exception, were either stable or positive. Now
there are four negative outlooks and four ratings on CreditWatch (two
with negative implications and two with developing implications) (see
Figures 1.6.1 and 1.6.2).
Even when accounting for the upgrades of corporate issuers, the gap
between Russias credit quality and that of the rated corporate sector
has increased. Following the sovereign upgrade in January 2004, the
only change in corporate ratings was an upgrade of the long-term
foreign currency rating on OAO AK Transneft the government-owned
monopoly oil pipeline operator to BB+, which reflected the improved
transfer and convertibility risks that were accounted for in the raising
of the sovereign foreign currency rating.
Bureaucracy continues to constrain credit quality

Instead of institutional frameworks serving as the foundation for fair
and efficient economic activity, as well as raising the general standard
of living for the population, the application of laws and regulation in
Russia is driven by personal agendas and rivalries and self-preserving
or rent-seeking bureaucracies that burden businesses and impede the
development of a more vibrant, diverse, and competitive economy. In
recent months there have been worrying signs that conditions are
getting worse, notwithstanding the passage of a number of pieces of
reform legislation. Effective implementation of new laws and regulations and reduction of the bureaucratic burden on business through
successful administrative reform is probably the most important challenge for the next administration.
Many of the reforms legislated or documented in 20012003 could
serve as the basis for progress. From the corporate standpoint, the
most significant new pieces of legislation include:
tax reform;
fiscal reform;
the new bankruptcy law effective since 2003;
electricity sector reform;
changes to corporate law;
currency control liberalization;
deregulation of small businesses; and
a more transparent tariff-setting framework for the electricity sector.
Questions remain as to the actual implementation and application of
many of these and whether the government culture shifts toward
59
serving the public, including private enterprises, as opposed to maximizing the power of the State and often its employees and their beneficiaries. In Russias still-developing business and regulatory culture,
personal or political motives, therefore, can prevail over economic
rationale and result in biased decisions or decisions that are unpredictable from a purely business standpoint.
Managing high social costs and overcoming resistance to change by
entrenched industrial and public sector interests are associated challenges. Russias administrative burdens delay economic modernization
and diversification and increase corruption risks. In the past, administrative burdens afflicted small and mid-size enterprises (SMEs) most
seriously and were a deterrent to foreign direct investment, but now
they seem an increasing threat to large Russian corporate entities as
well.
Along with regulators and other bureaucracies, Russian courts
remain unpredictable, which does not support fair and efficient
economic activity. The weakness of the judicial system results in inconsistent and sometimes selective application of the law. It is not unusual
to see different courts coming to contrary decisions on the same issue
or overruling each other on unclear grounds. The courts lack independence and often appear to be influenced by federal or regional politicians or by powerful business groups. Corruption in Russian courts,
therefore, remains a significant risk. Similarly, regulatory decisions
are often non-transparent, unpredictable, and politicized.
Corporate governance remains an issue

Russias corporate governance system is evolving and not yet firmly
rooted. Its very short and dynamic history started with the murky
privatizations of the mid-1990s and continued through the bitterly
fought struggles to establish large industrial groups in the late 1990s.
The idea that transparency and predictable corporate behaviour will
support higher market capitalizations only began to surface with a few
progressive corporate groups after the 1998 financial crisis, generally
when the key industrial groups had achieved strong control over their
key assets and ownership rights had been more or less settled. The
mindset of most decision-makers, both in public and the private
business environment, was formed in the Soviet era. As a result,
private property, entrepreneurship, and value-creation are relatively
new concepts, while government involvement in the economy and
prevalence of personal relationships over prescribed rules is perceived
as traditional. Many decision-makers still think in terms of control
rather than value creation. This results in poor protection of ownership
rights. The weaknesses of the countrys legal and regulatory systems
60
can still be exploited by the vested interests in the public and private
sectors; for example, to gain control of certain assets or cash flows.
The Yukos affair and similar cases have discouraged transparency
to some extent because it is perceived as making companies and shareholders vulnerable to outside threats. This reaction also hurts the
legitimate interests of portfolio investors and lenders, however, by
making it more difficult for them to assess risk and value and spot
conflicts of interest. It will be unfortunate if a fear of regulatory actions
or heavier government involvement in corporate affairs be it politically motivated or at the instigation of rival business groups with
political influence induces more companies to regress back to the sort
of aggressive corporate practices that prevailed in the late 1990s.
The legal, regulatory, and corporate governance uncertainties can be
illustrated most clearly by the Yukos affair, as well as the recent questioning of the Moscow telecommunications licence of VimpelCommunications (JSC) (Vimpelcom; B+/Stable/) and other
lower-profile cases. Yukos and its subsidiaries and shareholders are
the subject of numerous tax and legal investigations, including ones
into tax optimization practices that are widely used in Russia. Because
of legal and tax charges against the companys beneficial shareholders,
the court froze a 44 per cent stake in the company that the major
shareholders owned indirectly, via offshore legal entities. Meanwhile,
the former core shareholders of Sibneft in which Yukos had acquired
a 92 per cent stake just before Mikhail Khodorkovsky (the former chief
executive and major shareholder of Yukos) was arrested refused to
transfer governance and management control to Yukos and started to
reverse the transaction. Subsequent canceling by the court of Yukos
share issue used to purchase a 57 per cent block of Sibneft shares, and
the resulting conceivable loss of that block (unless the share cancellation is successfully appealed), was a further manifestation of court
actions that can impede corporate governance and finance in Russia.
The risk to companies under high-profile investigations can be
compounded by lower-level officials, some of whom in apparent
attempts to demonstrate their loyalty and zeal have initiated
narrower investigations of their own into taxes, oil production licences,
or assets. Although there have not yet been any high-profile defaults as
a result of official actions, these actions compound the normal financial
and business risks that companies face in markets where legal regulatory and governance systems are more developed and predictable.
The practical implementation of regulatory and judicial reforms will
be key for Russias corporate sector environment. In particular this
should include:
Administrative reform which streamlines the compliance process
and reduces the unnecessary interference of government in business
including greater accountability, reengineering of work processes,
61
and staff optimization within the bureaucracy. Real reform, not just
a redistribution of the government functions in token compliance
with legislation, is essential to boost the efficiency, flexibility, and
competitiveness of Russian companies.
Judicial reform that must increase the fairness, efficiency, and
predictability of the environment that businesses and creditors face.
Judges also need to be more aware of the needs of the business
community. On many occasions, individual judges lack of knowledge
and conservatism have posed a greater obstacle to development of
business than the legislation.
Interplay between corporate governance and regulation that
encourages a better governance, credit quality, market, and
regulatory culture.
Centralized and personality-driven political

system adds risk
For large businesses, particularly in the resource sector, the growing
concentration of power in the presidential administration creates new
uncertainties. Without effective checks or balances from the legislative
or judicial branches, and with a civil service in need of drastic reform,
this concentration of power threatens to increase the already personalized relationships between business and government that, coupled
with a resurgence of nationalist sentiment and questioning of existing
contractual and property rights, heralds a period of uncertainty for the
Russian corporate sector.
The December 2003 parliamentary elections were a victory for the
pro-president centrist party United Russia. They also demonstrated
the popularity of a nationalistic economic policy aimed at strengthening
the governments role in the resource sector and increasing the sectors
tax burden. If centrist parties play to the popularity of a nationalistic
agenda, it could negatively affect the tax regime and undermine some
recent efforts to liberalize the business environment. A nationalistic tilt
might also hamper foreign direct investment, expose selected
companies or businessmen to political pressure, and affect corporate
governance and transparency incentives and practices.
The Yukos case is unique because of the company shareholders
unusually heavy involvement in politics, but without clear-cut
protection under the law and principles of government other
companies or institutions have to rightly factor in the risk that they too
could attract the particular attention of the authorities. For example,
Vimpelcom was subject to a licence investigation that was both begun
and ended with suddenness and little explanation. In the pre-eminent
62
oil and gas sector, the government recently invalidated the licence for
Exxon Mobil Corp. (AAA/Stable/A-1+)-led Sakhalin-3 oil exploration
project. Although massive nationalization looks very unlikely at this
stage because private property is already deeply entrenched and the
key industries have been essentially privatized the security of title,
property rights, and contracts is a risk factor that must be weighed in
by both direct and portfolio investors in Russia.
The trend toward political and fiscal centralization should help ease
the threat of pressure or action by regional authorities against businesses in the future. In regions where governments have been heavily
involved in the economy, however (such as Bashkortostan, Tatarstan,
and Yakutia), the centralization process might imply uncertainties in
shareholding or corporate governance, sometimes in the form of tax or
regulatory pressures. For example, right before the elections in late
2003, in the Republic of Bashkortostan (B+/Stable) the regions key oil
firms, Bashneft and Bashneftekhim, were privatized in a questionable
way by the setting up of a cross-shareholding structure that was effectively controlled by the management, which is close to the family of the
former head of the region. The companies were subject to tax investigation, while the share issue of the regions key bank, Ural-Siberian
Bank (OJSC) (B-/Stable/C), was contested in the court, triggering an
outlook change from positive to stable. Both cases appear to have been
settled after the president of Bashkortostan achieved a compromise
with regional authorities and was re-elected to his office.
Standard & Poors believes that creditors of government-owned
companies are unlikely to benefit from the recent rise of nationalistic
sentiment and the trend toward centralization. These organizations
continue to face regulatory risks, which have been incorporated in the
ratings on the entities. It is important to bear in mind that government
interests are typically focused on the companies current operations
and long-term strategic projects rather than on avoiding a corporate
default, because a default does not necessarily imply bankruptcy or
liquidation. Recent fiscal legislation makes it almost impossible for the
government to arrange for a timely direct financial support in the
event of a liquidity crisis. Russian state-owned companies, therefore,
receive little, and normally no, benefit in the ratings as a result of their
ownership. Although these companies business profiles might benefit
from a degree of state support or even occasional politically motivated
lending by the state-owned Savings Bank of the Russian Federation
(Sberbank), their stand-alone credit quality can be affected by
nontransparent populist-driven regulations, pressure for politically
motivated investments, and generally less sophisticated management
and corporate governance risks as well. For example, the rating on
OAO Gazprom (BB-/Stable/), Russias gas monopoly in which the
government holds majority control, is constrained by its low regulated
63
domestic prices. In effect, the company shoulders the social burden for
the government. RAO UES of Russia (B/Positive/), the countrys
majority government-owned electricity monopoly, has a rating that
reflects restructuring, regulatory, and other uncertainties.
Despite many uncertainties about the nature and extent of the
influence of the government sector on corporate ratings, political
unrest looks very unlikely. President Putins wide popular support,
coupled with Russias strong presidential system and the Dumas
composition after the December 2003 election, ensures wide legislative
support if the new presidential administration wants to continue
current reforms. Of importance is how committed to, and effective, the
new administration will be in achieving desperately important administrative reforms that will both facilitate the broader range of policy
implementation and lift the burden of government from business.
Economic concentration adds further

constraints to growth
Russias economy remains very concentrated in terms of its dependence on oil and gas and a few other natural resources as well as the
concentration of private firm ownership in a relatively small number of
financial industrial groups (which are controlled by Russias
oligarchs). These structural characteristics mean that a downturn in
the oil sector is a risk even for firms with little direct or obvious
exposure to it. This vulnerability is not likely to be reduced in the near
to medium term.
The dependence on oil and gas can be seen in the fact that those
sectors accounted for 58 per cent of exports and an estimated 23 per
cent of GDP in 2003, while metals accounted for a further 17 per cent of
2003 exports. The dominance of large financial industrial groups in
Russia increases the risk that problems at one or more major members
of a financial industrial group could ripple through the group affecting
members and their main counterparties. The diverse economic cushion
of modern SMEs remains underdeveloped and faces impediments to
growth from the administrative burden of government bureaucracy
and the underdeveloped banking system.
Incentives for transparency provide hope

The general level of transparency and disclosure in Russia is
improving, albeit from a very low base and with large variances from
one company to another. As capital markets become a more important
source of financing, this improvement is expected to continue. The
government is planning a gradual implementation of IFRS- or US
64
GAAP-based reporting starting with banks and listed companies and

continuing somewhat later more broadly. Even if the process takes
more time, the positive trend is obvious. For most rated companies, the
key issue is the timeliness, rather than the level, of disclosure.
Timeliness is hampered by the limited supply of accountants with a
good understanding of IFRS or US GAAP accounts and the typically
two-stage approach of basing these accounts on Russian statutory
accounts with necessary adjustments and clarifications.
Transparency and corporate governance has markedly improved in
recent years, but still remains an important issue. Complex corporate
structures emerged during privatization, to avoid burdensome regulations or to optimize taxes. This applies to many newcomers to
capital markets such as OAO Caustic (CCC+/Stable/) and OAO
Plastcard (CCC+/Stable/) but also to some large corporate players.
Typically, such companies have significant related party transactions
and it is difficult to determine whether they trade at an arms-length
basis and to create an appropriate financial and accounting picture to
analyze.
Shareholding structures are often obscure. National disclosure standards only require disclosing large names listed in the shareholder
register and do not extend to the beneficial shareholding level. In many
cases, therefore, the actual interests behind a particular company
cannot be known with confidence. Shareholder disclosure is hampered
by the fear of corporate raiders, property rights protection, large tax
bills, or government pressure. The progress in this area is slow,
although there are some examples of improving standards of
disclosure such as Mobile TeleSystems OJSC (B+/Stable/), WimmBill-Dann Foods OJSC (B+/Negative/), LUKoil (BB/Stable/), and
OAO Severstal (B+/Negative/) as well as some smaller companies.
Concentrated shareholding structures affect predictability and
transparency by making companies overly reliant on several key
decision-makers and prone to large unexpected transactions such as
dividends and M&A. Even if such transactions are disclosed, the
companys destiny is very much in the hands of a particular individual
with little accountability to minority shareholders or creditors.
In the future, the incentives to be transparent will largely depend on
the balance between the access to capital markets, particularly the
ADR market where shareholding disclosure is required, and the risks
of pressure from the government or aggressive takeover attempts.
After looking at the Yukos affair, some companies might be more
cautious in their disclosure but because the story has not affected their
access to the capital markets so far, the incentives to be more transparent in order to raise capital should prevail.
65
Increased appetite for emerging market debt

offsets weak banking system
Russia continues to have a weak and undercapitalized banking
system, which increases liquidity risk for Russian corporations. Many
banks are captive or treasury operations of large industrial groups and
a lack of economic diversification affects the banks ability to grow and
diversify their customer base. The level of intermediation is lower than
in peer countries: the amount of credit issued by domestic banks to the
private sector is low at only 21 per cent of GDP. Most Russian banks
are rated well below Russian corporations (see Figure 1.6.3).
16
14
Corporates
12
Banks
10
8
6
4
2
0
CCC
cat
B-
B+
BB-
BB
BB+
Figure 1.6.3 Russian corporate and bank ratings distribution on

4 March 2004
Although progress is being made, Russias credit culture remains
immature. Bank and bond markets are vulnerable to shocks and
surprises due to investment and lending decisions being based on relationships, reputations, or other considerations rather than solid information and analysis. As a result, some companies can opportunistically
borrow to fund aggressive investments in M&A, or borrow while
keeping large cash balances and thereby expose themselves to weak
financial institutions or currency risk.
Russian companies do now, however, have much better access to
capital, both domestically and internationally, and this is a significant
positive factor for credit quality. Since 20022003, large companies
have had easy access to the international bond and bank loan markets,
supported by strong international demand for emerging market debt
and Russias solid economic growth. As a result, foreign corporate debt
grew fast in 2003. Notwithstanding the Yukos affair, the international
66
demand for Russian debt has not decreased, as illustrated by several

successful eurobond placements in late 2003 to early 2004. Even if
international investor interest is volatile in the mid term, Russian
issuers are not likely to be totally cut off from financing, as they were
shortly after the 1998 crisis. Russias ability to service all its debt in the
short term remains relatively strong and the risk of a sovereign default
is minimized by the countrys very strong external liquidity position
and the governments short-term fiscal flexibility.
Meanwhile, domestic bank credit and capital markets have been
growing fast, albeit from a low level, so that Russia now has the largest
bond markets in Eastern Europe. Oil revenues have created a liquidity
cushion on the domestic financial market and provided funding opportunities for midsize companies. These factors improve corporate
liquidity in the short term, but Russias corporate sector would still
benefit greatly from a strengthening of the domestic banking system.
Country risks still dominate outlook

The diverse range of outlooks and a significant number of CreditWatch
placements suggests that Russian corporate ratings are likely to be
volatile in the year ahead following their strong, steady, upward movements in recent years. In the short term, the ratings will be significantly driven by industry and company-specific factors rather than by
sovereign rating dynamics.
Transparency and predictability of companies financial policies in
areas like M&A, debt, and liquidity will become as important as operating and financial indicators. Although general country risk is already
factored in Russian corporate ratings, if a company becomes exposed to
an unusual amount of regulatory or legal pressure such as with
Yukos a CreditWatch placement or downgrade is possible. Overall,
these factors are company-level reflections of two country-level issues:
corporate governance and government interference.
The mid- to long-term outlook for Russian corporate ratings will be
significantly determined by indirect sovereign factors, particularly by
the countrys progress or regress in a worse-case scenario in terms
of establishing robust and independent legal and regulatory institutions, developing healthy corporate governance practices, making the
relationships between the government and the corporate sector more
predictable, and reducing the bureaucratic burden on business. These
indirect factors will be no less important for corporate ratings in
Russia than the sovereigns fiscal and macroeconomic performance.
Part Two
The Financial Sector
2.1
The Russian Banking

System: An Overview
Regulatory system: The Central Bank

The Russian banking system is headed by the Central Bank of Russia
(the CBR) the institution that prints money, maintains Russias
currency reserves, implements currency control legislation and
licences, regulates and supervises Russian banks and other credit
organizations (eg those of clearing houses). It also owns a controlling
interest in Sberbank, the national savings bank, and, until recently,
Vneshtorgbank (VTB), the countrys foreign trade bank (together
Russians largest banks), keeps budgetary accounts and accounts of
state agencies and authorities, runs the national settlement system
and conducts banking transactions. All of this is done at the same time
by the same entity.
These extensive powers have been, and still are, the subject of a
lengthy and rigorous political struggle, which has resulted in the CBR
gradually, over the course of the last few years, losing some of its
powers and privileges. For example, since 1997 the CBR has been
obliged to transfer 50 per cent and, as of 2004, 80 per cent, of its profits
to the federal budget (but still retains the remaining 20 per cent) while
previously it kept all its profits, including seniorage. Around
19961997 the CBR lost out to its long-standing rival the Federal
Financial Markets Service (the FFMS) and as a result the activities
of Russian credit organizations in the securities markets (eg brokerdealer operations) are now licensed by the FSMC rather than by the
CBR. In 2001, the CBR lost the fight to control money-laundering
activities under the new anti-money-laundering law these are now
controlled by a separate, newly-created agency, with the CBR playing a
more limited role. However, the worst year in the CBRs history was the
year 2002, when the new Law on the Central Bank of Russia, adopted
at the initiative of the Russian President, Mr Putin, expanded the
70
authority of the National Banking Council, the public body designed to

supervise the CBR, and significantly increased the influence of the
Government, the legislature and Russian regions, over CBR policy. In
addition, in 2002, the Government persuaded the CBR to sell its
shares in VTB at their nominal value and to receive in exchange rouble
denominated bonds bearing just six per cent interest and having a
maturity of nine years.
Nevertheless, despite these developments, the CBR is still a
powerful agency keeping tight day-to-day control over virtually every
Russian credit organization. In order to carry out its functions the CBR
employs roughly 83,000 people and maintains 78 local branches
throughout Russia.
History
The modern Russian banking system originally emerged through the
introduction of the 1990 Law on Banks and Banking Activities. In just
a few years, more than 2,000 banks came onto a scene previously
occupied only by the CBR, Sberbank, Vnesheconombank (VEB),
Promstroybank and a few other ex-Soviet state banks. This high
number of banks, however, neither represented the same quality nor
corresponded to the level of economic development in Russia at that
time. Most of the banks profited either by servicing accounts of state
authorities (with the most lucrative ones being, perhaps, the customs
and tax authorities) or by trading on the speculative GKO (ie state
short-term bonds) market.
The August 1998 Crisis

Not surprisingly, the collapse of the Russian GKO market during the
so-called August 1998 Crisis (the Crisis) was a heavy blow to the
fledgling Russian banking system. The results were shocking: many
banks went bankrupt (with the most famous examples being SBSAGRO, Rossiiskiy Credit and Inkombank) and hundreds of thousands
of people lost their savings. The adoption of the Budgetary Code in
1998 and the subsequent transfer of most of the budgetary accounts to
the Federal Treasury left many surviving banks without stable sources
of income. According to the CBR, during the period from 1997 to the
end of 2001 the number of operating banks dropped from 2,029 to
1,319. Despite the CBRs plans to tighten control over the existing
banks and, thus, to force banks without a future to close, the total
number of banks has slowly grown during the last two years and, on 9
July 2004, reached 1,579.
71
Current status of the Russian banking system

Obviously, it is easier for the larger banks to survive. However, the
current level of merger and acquisition activity is rather low.
Immediate post-Crisis restructuring activities were limited to asset
stripping and changes of name, as bank owners busied themselves
hiding assets from their creditors. Many of the reported mergers
represent intergroup restructuring (eg the merger of Alfa Bank with
Alfa Capital, and the merger of Bank Austria with International
Moscow Bank due to the merger of their parent companies/banks in
Germany and Austria), rather than mergers in the true sense. While
various acquisitions of small regional banks by their larger counterparts have been reported, the only memorable examples of any real
M&A activity are the successful acquisition by Nikoil of Avtobank and
UralSib, acquisition of the 1st OVK group of banks by Interros Group
(which includes Rosbank), and the most recent acquisition of the failed
(during the summer 2004 banking crisis) GUTA-Bank by VTB and
acquisition of Russian Standard by BNP Paribas.
The current league table of the largest Russian banks is headed by
ex-Soviet giants such as Sberbank, VTB and VEB. However, the league
includes newer names as well, eg Alfa Bank, Gazprombank (controlled
by the Russian gas monopoly Gazprom), International Industrial
Bank, Rosbank, Bank of Moscow, MDM, Nikoil (controlled by Lukoil,
one of the largest Russian oil producers), UralSib (undergoing acquisition by Nikoil) and Sobinbank.
There is no prohibition against foreigners establishing Russian
banks or buying shares/participation shares in existing Russian banks.
However, the acquisition of more than 5 per cent of the shares/participation shares in a Russian bank needs to be declared and the acquisition of more than 20 per cent of the shares/participation shares
requires prior consent from the CBR. The Government plans to change
both these figures to 10 per cent. Federal law can dictate the overall
limit on foreign investment in the Russian banking system. To date,
however, no such law has been adopted. As of 1 April 2004 there were
128 (compared to 126 in January 2002) banks with foreign capital,
including 33 (23 in January 2002) that are wholly foreign-owned, and 8
banks with a majority foreign participation. This demonstrates a
significant rise in foreign investment in the Russian banking sector
over the last two years. The top 100 banks include several subsidiaries
of foreign banks, eg ABN AMRO, Citibank, CSFB and ING.
Obviously, size alone does not necessarily correspond to the level of
commercial activity/profitability. For example, the commercial activities of VEB are rather limited and it mainly performs agency functions
in relation to Russian external debt.
72
The strongest Russian banks are typically members of the larger

financialindustrial groups and often perform mostly treasury functions. The most probable explanation for this is that there are simply
not enough trustworthy banks in the country to service the large
Russian corporates and, as a result, they have had to establish/acquire
their own banks. In 2002, the Ministry of Anti-monopoly Policy
declared its plans to prohibit shareholders/owners of banks from maintaining their own bank accounts in the banks they control, as this
reduces the competition as it means there are simply not enough
valuable clients left in the banking services market for other banks.
Not surprisingly, these plans have been widely criticized and, as a
result, they have not been implemented.
The main problem of the Russian banking system is, of course, its
under-capitalization. As of 1 April 2004, Russian banks as a whole had
only 814.19 billion roubles (compared to 453.9 billion roubles on
1 January 2002) of their own capital (approximately $27.99 billion at
the exchange rate of $1 to 29.09 roubles) and their total assets were
approximately 5.6 trillion roubles (approximately $192.5 billion at the
exchange rate of $1 to 29.09 roubles), compared to 3.2 trillion roubles
on 1 January 2002. Thus, the capitalization of the Russian banking
sector has almost doubled over the last two years, but is still at the very
modest level.
National currency and currency control legislation

The Russian rouble, the national currency of the Russian Federation, is
not yet freely convertible. The new Law On Currency Regulation and
Control No. 173-FZ dated 10 December 2003 (the Currency Law)
envisages that the Russian rouble will become freely convertible from
1 January 2007. Due to the instability of the Russian economy and
high inflation levels, the rouble often loses out to the dollar and other
hard currencies in terms of peoples preference. Banks, corporates and
individuals often prefer to keep their reserves and savings and to
receive their income in dollars or other hard currencies, rather than in
roubles. It is worth mentioning that even the Russian budget is
prepared on the basis of the estimated rouble to dollar exchange rate.
Capital flight is estimated to be in the region of $2040 billion per year.
In order to support the rouble, Russia maintains rigid currency
control legislation. As a general rule, all settlements between Russian
residents may be conducted only in roubles. Exporters must repatriate
their hard currency proceeds back to Russia and convert 25 per cent of
their export proceeds into roubles on the Russian currency market
within seven days of receipt of hard currency. At some stage after the
Crisis, the portion of the export proceeds subject to mandatory
73
conversion into roubles was further increased to 75 per cent; however,

it was later reduced initially to 50 per cent and then back to the
original 25 per cent level. The Currency Law envisages that mandatory
conversion, as well as certain other restrictions (such as special
accounts, prior registration of the transaction and reserve requirements) will be cancelled altogether by 1 January 2007. As a general
rule, Russian exporters should receive export proceeds within 180 days
of the export of goods or services (this is one of the positive changes
introduced by the new law on currency regulation and control). The
acquisition of hard currency is no longer restricted.
While the Currency Law clearly introduced a more favourable legal
regime for exporters and importers, it remains to be seen how this will
affect foreign and Russian investors, manufacturers and other
businesses.
Russian banks with a CBR licence permitting them to conduct operations in hard currencies, the so-called Russian Authorized Banks, act
as agents of currency control, ie they control every single payment by
residents and non-residents. The Currency Law has weakened the
position of Russian Banks by allowing Russian residents (legal entities
from 19 June 2005) to open foreign bank accounts in OECD or FATF
countries. It is expected that this will significantly increase competition between Russian and foreign banks.
Bank lending
As described above, Russian currency control legislation creates
various barriers to the use of hard currencies. Russian law, however,
allows the parties to a contract to express monetary obligations in hard
currency (or any other equivalent) so long as the obligation is actually
performed in roubles. Not surprisingly, the bulk of bank loans in
Russia are either made in hard currency or are linked to a particular
hard currency, which results in borrowers bearing the risk of exchange
rate fluctuations.
Due to high inflation rates (which are usually higher than those
reported in official statistics), few banks offer long-term loans. Loan
terms rarely exceed three years and interest rates are prohibitively high.
The Russian tax system is undergoing significant change and the
situation is slowly improving. Nevertheless, the effective taxation level
is unreasonably high when compared with that in the West. Russian
accounting standards are designed mainly for taxation purposes
rather than for the purposes of making investment decisions. They
differ from international and US accounting standards and do not
always reflect the true state of companies financial affairs. As a result,
creative tax planning and accounting is widely used in Russia; the
74
Yukos case is just one example of such practices. Coupled with the fact
that there are no credit reporting bureaux in Russia, this often leaves
banks in a difficult position when considering whether to grant a loan,
as they have to assess credit risks on the basis of limited and often
unreliable information. Therefore, banks generally grant loans only to
their long-standing customers, though exceptions may be made for
large companies with proven track records, especially in exportoriented industries. It is expected that the credit bureaux will be
created soon, as the relevant draft laws have already been submitted to
the State Duma.
Since foreign banks have access to international capital markets
they are often able to offer lower interest rates and longer-term loans
to Russian borrowers of an appropriate calibre than their Russian
rivals can. As a result, foreign banks, together with their subsidiaries,
occupy a significant share of the corporate lending market for large
Russian borrowers (transactions are often, for various reasons, negotiated in Russia, but are documented as taking place abroad).
Investment banking
The Russian securities market is at a fairly early stage in its development and is slowly recovering after the Crisis. Legally, Russian
banks are not divided into investment banks and commercial banks.
Generally, all major banks are big players in the Russian securities
market, whether directly or through their investment companies. It is
worth mentioning that while Russian banks occupy most of the positions in the relevant league tables, first place is often taken by CSFB.
Retail banking
As many people suffered and lost out during the Crisis, the level of
trust enjoyed by Russian banks is generally relatively low. In order to
overcome this situation, Russia finally introduced, at the very end of
2003, a system for guaranteeing private deposits/mandatory insurance
of private deposits. The CBR majority-owned banks (eg Sberbank) will
continue to enjoy special status until 1 January 2007: their contributions to the relevant insurance fund cannot be used to make payments
to the depositors of other banks and the Russian Federation will be
secondarily liable for their debts to private depositors.
The Government and the CBR claimed that the new deposit
insurance system would make any new banking crisis and related
panic impossible, as depositors would be confident that their savings
would be protected. The summer 2004 banking crisis emerged from
75
nowhere and proved that both the Government and the CBR are often
wrong.
GUTA Bank failed completely and was purchased by VTB for a
nominal consideration of 1,000,000 roubles. Alfa Bank lost half of its
private depositors and managed to survive only through the support of
its shareholders (who have injected into it 700 million cash) and the,
unprecedented for the Russian market, introduction of a 10 per cent
commission for early withdrawal by private clients of their deposits a
measure considered illegal by the legal community.
The CBR rushed to lobby for legislation that would provide compensation to the depositors of those banks that did not join the mandatory
deposit insurance scheme. This was not exactly consistent with the
idea that only selected banks would be allowed to join the mandatory
deposit insurance scheme and only depositors of such banks would be
provided with some sort of state/CBR guarantee/support. Perhaps this
is explained by the fact that, at the outset of the summer 2004 banking
crisis, there was not a single bank that had managed to complete the
lengthy procedure for joining the mandatory deposit insurance
scheme.
The retail banking market is heavily dominated by Sberbank, which
attracts most private deposits; its market share has increased since
the Crisis and the collapse of its nearest competitors such as SBSAGRO and Inkombank. For example, in 2001, Sberbank attracted 72.1
per cent of all private deposits (82.5 per cent of all private rouble
deposits and 51.3 per cent of all private hard currency deposits), had
the largest credit portfolio and received the largest profits in the whole
banking sector. This achievement reflects the high public confidence
enjoyed by Sberbank, which enables it to pay a relatively low interest
rate on deposits. However, the increased competition in the market for
retail banking services has led to Sberbank losing its position to
competitors. For example, in 2002, its share of the private deposits fell
to 64.2 per cent.
After the Crisis, the CBR urged foreign banks to start retail operations. Some foreign banks have complied with the request and several
of their subsidiaries (eg Raiffeisen Bank and International Moscow
Bank) have achieved notable success in attracting the funds of highincome individuals. However, their operations are limited to just a few
branches in Moscow and some other major Russian cities and cannot
be compared with the tens of thousands of branches maintained by
Sberbank. It is worth mentioning that foreign banks pay an even lower
interest on deposits than Sberbank.
At present, foreign banks do not target low-income clients and
structure their tariff policy accordingly. ABN AMRO, for example, does
not offer private banking for individuals unless they are employees of its
corporate clients. However, in 2003, Russian banks became increasingly
76
attracted to the retail banking market and many of them rushed to offer
their services to individual customers. As a result, the competition in this
market increased.
Mortgage financing
Mortgage financing is at an early stage in its development, but is developing at a rapid pace. Interest rates begin at over 10 per cent per
annum for hard currency or hard currency linked loans.
Apart from the problems described above in relation to banking
transactions generally, there is one further obstacle to the development of mortgage financing. According to Russian law, in order to be
valid, a real estate mortgage has to be notarized. The notary fee is set
by law at the ridiculously high level of 1.5 per cent of the value of the
contract, ie the mortgaged property. This requirement creates an
unjustified expense for borrowers and seems unnecessary in view of
the introduction, in 1998, of state registration of rights to, and transactions in, real estate. The Government has finally prepared and
submitted to the State Duma a set of 19 draft laws designed to
improve the legal environment for mortgage financing and residential
development, which will get rid of mandatory notarization of mortgages and will introduce a significant number of other improvements
to the relevant legislation.
Plans for reform

On 30 December 2001 the Government and the CBR released their
joint Strategy for the Development of the Banking Sector of the
Russian Federation (the Strategy). The Strategy lists plans for future
reform of the banking system. Among rather general statements of the
goals, the Strategy includes several specific steps worth mentioning
(some of which have already been implemented):
The Government will dispose of its minority interest (25 per cent or
less) in all banks, will consider on a case-by-case basis whether it
should dispose of its interest in other banks where its participation
exceeds 25 per cent and will not create further new state banks
this process has already started but is far from complete.
The commercial business of VEB will be transferred to VTB, with
VEB continuing to perform agency functions in relation to Russias
foreign debt. The press reported that this process has now been
completed.
77
The Government, jointly with the CBR, will tighten control over
Sberbank; the CBR will continue to be the majority shareholder in
Sberbank.
All Russian entities (and not just banks) were to switch to international accounting standards by 1 January 2004. In fact, as of July
2004, this has been implemented in relation to banks only. It
remains to be seen when this will be implemented in relation to nonbanking institutions.
Creation of aA system for guaranteeing/mandatory insurance of
private deposits will be created this has been implemented.
Credit bureaux will be created. The relevant draft law was included
in the mortgage package recently submitted to the State Duma.
There will continue to be no legal restriction on banks combining
investment with commercial business.
There will be no limit on the overall foreign investment in the
Russian banking system.
The CBR will consider allowing foreign banks to operate in Russia
through their branches. It appears that this process is taking CBR
considerably more time than might reasonably have been expected.
The CBR will dispose of its interest in Soviet Foreign Banks (ie its
foreign subsidiaries). The press has reported that this plan has
encountered strong resistance from the regulatory authorities in the
countries where these banks are located.
Improvement in the protection of pledgees; a system for registering
pledges of movable assets. At this stage there is no evidence of any
progress on this matter.
The press reports that the Government is currently considering the
Strategy of Development of the Russian Banking System in 2004 and
up to 2008. However, this document has not yet been officially
published.
Experience shows that not all plans are implemented as intended,
especially where the plans are those of the Russian Government and
the CBR. However, despite the failure to implement all plans within the
original time-frame, the steps already taken by the Russian President
and the State Duma in the sphere of currency control legislation and
the ongoing efforts in relation to the development of mortgage financing
send a clear message that they are eager to avoid old mistakes and to
make things happen, albeit at a relatively slow pace.
78
Table 2.1.1 Major Russian banks (as at 28 July 2004)

No.
Name
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
VNESHECONOMBANK
SBERBANK OF RUSSIA
VNESHTORGBANK
ALFA-BANK
GAZPROMBANK
INDUSTRY AND CONSTRUCTION BANK
CITIBANK
MDM BANK
BANK OF MOSCOW
ROSBANK
URALSIB
INTERNATIONAL INDUSTRIAL BANK
INTERNATIONAL MOSCOW BANK
RAIFFEISEN BANK AUSTRIA
SBS AGRO
PETROCOMMERZ
INCOMBANK
NOMOS BANK
VOZROZHDENIYE
PROMSVYAZBANK
AUTOBANK-NIKOIL
SOBINBANK
GUTA BANK
MENATEP SAINT PETERSBURG
NIKOIL
ABN AMRO BANK A.O.
BANK ZENIT
GLOBEX
TRANSCREDITBANK
I MPEXBANK
Please note that GUTA-Bank was acquired by VNESHTORGBANK.
2.2
Retail Banking
Deloitte & Touche
Russias renaissance since the August 1998 crisis has been staggering.
While the US economy has grown by 23 per cent a year and Europes
economic growth has practically flat-lined, Russias real GDP has
grown by over 20 per cent and its industrial production by 30 per cent.
In different circumstances the currencys subsequent depreciation
would have been viewed as undermining the economy, but for Russia it
has done no harm, boosting local production, export and investments
and making industry much more competitive overall. Oil prices have
brought Russia significant revenues and in the banking sector,
deposits and loans have doubled. Anyone who invested in Russian
equities can now retire.
However, despite making significant strides, reform in the economy
and, more particularly, reform in the banking sector, is far from
complete and manifold problems persist.
The Russian banking sector remains highly concentrated and, at the
same time, fragmented, with all banks apart from Sberbank, Russias
largest retail bank, holding only tiny market shares. Unfortunately the
consolidation that would make the system more efficient and better
capitalized upon, is not materializing. This can be largely attributed to
the fact that Russian merger laws stipulate that in order to consolidate
banks, the permission of each and every individual depositor is needed
before a deal can go ahead.
The recent appearance of major US and European players on the
Russian banking scene (Citibank, Credit Lyonnais, Deutsche Bank, etc)
promised a profound change in the way retail banking business was
being run. Awaiting quick improvements, changes in the Law on
Registration of Banks and Foreign Participations were made, eliminating the 12 per cent foreign ownership limit. However, this initiative
has failed to result in a flood of foreign capital. Generally, foreign banks
still view the market as risky, ruling out other potential paths to reform.
Even the recent upgrade of Russian sovereign debt to investment grade
by Moodys did not contribute much to the overall sense of stability. The
outflow of capital from Russia due to the relatively high level of political
80
and national risk is still weighing down on the Russian banking system.
Another major obstacle for attracting foreign investment is the
specifics of doing business in Russia, including the rigorous administrative and bureaucratic requirements.
The introduction of deposit insurance, a much-needed step towards
increasing the overall trust in the banking system, is being constantly
delayed due to political disagreements. The same situation affects
improved supervision, greater transparency, etc. One of the major
problems, however, is the lack of reliable and accurate credit information on Russian companies and individuals, since there are no
parallels to credit bureaux and rating agencies. The lack of trustworthy
information sources creates situations whereby banks cannot evaluate
the credit standing of a potential borrower. International banks and
companies seeking to extend credit to Russian companies are also
unable to evaluate the credibility of a potential borrower. Such situations are aggravated by the fact that banks are unwilling to share
whatever information they may have accumulated on their own. It is
generally expected that this lack of publicly available information will
exist for the foreseeable future.
One of the consequences of this trend is that the banks are reluctant
to extend credit, due to the lack of the information necessary for risk
assessment. This constitutes a significant problem for individuals as
well as small- and medium-size enterprises (SMEs), who either cannot
qualify for or attract credit on reasonable terms. This in turn leads to a
situation where both individuals and SMEs have to rely on personal
ties, connections and informal channels, thus narrowing the circle of
potential partners, buyers and suppliers and hindering the overall
development of the retail banking business.
In spite of the above-mentioned issues, bank deposits have been
growing. At the same time, Sberbanks market share has dropped from
75 per cent in 2000 to 68 per cent today, and brokerage Troika Dialog
foresees it falling to 63 per cent by 2005. The most aggressive local
player in the retail market is Alfa Group, with its Alfa Bank Express
project, though rivals such as Rosbank and MDM Bank are also
expanding. However, foreign banks have better chances of attracting
clients, partly due to their non-involvement in the devastating 1998
crisis and partly due to their offering of services new to Russians, such
as online banking and security alerts to prevent unauthorized transactions. Additionally, foreign banks are bringing Western standards of
customer service that are new to Russian customers.
As far as lending is concerned, Russian Standard Bank, the first
local bank to specialize in consumer loans, has extended over $410
million in loans since it was set up in 1999. At the same time Raiffeisen
Bank has $90 million in retail loans. Rising incomes and consumer
demand have led to a surge in car loans and mortgages. These loans are
Retail Banking
81
a high-profit business. The margin on a retail loan in Russia is typically around double that on an equivalent loan in Western Europe.
Average interest rates on rouble deposits are little more than 5 per
cent, while rates on retail loans average at around 15 per cent. The big
challenge for many newcomers, however, is distribution. Citibank, for
instance, currently with only two branches, is relying on telephone and
Internet banking, a network of automated-teller machines at British
Petroleum gas stations around the capital, and alliances with local
retailers. Societe Generale is also well behind its schedule of opening
branches, due to a lack of appropriate real estate, a problem which
other players have so far managed to avoid.
What is clear is that as Russias economy stabilizes and the
memories of the 1998 crisis fade, middle-class Russians are increasingly turning to banks to keep their money. At present, it is estimated
that only 33 per cent of savings are kept in the banking sector, so there
is a huge opportunity to attract new customers to the industry.
It is obvious that the country still has a long way to go and any letup in the reform process could be devastating. Potential as well as
existing players in the Russian banking market, both domestic and
foreign, should carefully weigh up all the downsides of the initiative to
avoid being blinded by the potential revenues.
2.3
Twelve Years of the

Russian Insolvency
Regime
History
Initial legislation
Back in the old days of the Soviet Union, there was no insolvency legislation because almost everything was owned and controlled by the
State. Later, when the market reforms got under way there arose the
need for a mechanism to deal with the insolvency of market participants. The legal vacuum could not exist for too long and on 14 June
1992 the President issued Decree No. 623 on Measures for the Support
and Rehabilitation of Insolvent State Enterprises (Debtors) and the
Application to them of Special Pro-cedures (the Decree).
The Decree was fundamentally flawed. Firstly, as follows from its
title, it applied only to state enterprises (which included enterprises in
which the State had a shareholding of at least 50 per cent) and did not
apply to private companies or individuals. Critics of the Decree could
not see much point in the State initiating special insolvency procedures in relation to wholly-owned state enterprises rather than simply
liquidating them a process which was already within the powers of
the State in its capacity as owner of the enterprise.
Secondly, the Decree envisaged out-of-court insolvency proceedings
to be administered by the relevant State Property Committee in the
case of wholly-owned state enterprises or a commission of the owners
of the enterprise in the case of partially state-owned enterprises
(both referred to hereafter as the Owners). Obviously, the Owners of
insolvent enterprises did not prove to be the right people to protect the
interests of the creditors of those enterprises.
Thirdly, the Decree envisaged that the Owners would review the
insolvency petition and determine whether the debtor was insolvent by
83
applying the so-called inability to repay/inadequate assets insolvency

test, (ie a debtor was deemed to be insolvent only if its total debts
exceeded twice the value of its assets). In practice this was a difficult
test to meet as most state enterprises had numerous non-productive,
and often absolutely illiquid assets, on their balance sheet.
Once a debtor was acknowledged to be insolvent, its Owners were to
prepare a rehabilitation plan specifying the time frame for which the
insolvent enterprise was to be under so-called independent
management (618 months) of an independent manager (which could
also be a foreign entity) selected through an auction process (and which
had to have provided security in the amount of not less than 10 per
cent of the balance sheet value of the debtors assets). While the powers
of the independent manager were quite wide, it could not make more
than 30 per cent of the workforce redundant, which often left little
room for manoeuvre.
In light of the above, the Decree was never considered successful in
achieving its ends.
The first insolvency law

On 19 November 1992 the legislature took a lead from the President
and adopted the first Russian law on bankruptcy (the First Law). The
First Law was a step forward in comparison with the Decree.
Firstly, it applied to all commercial legal entities and entrepreneurs
irrespective of their form of ownership. Secondly, the insolvency
proceedings were to be administered by the Arbitration Court (ie the
Russian State commercial court) rather than by the Owners.
The First Law reduced the insolvency threshold by half (ie the
debtor was considered insolvent if its total debts were equal to or
exceeded the value of its assets). An insolvency petition could be filed
by a creditor only if the debtor failed to pay debts equal to or exceeding
500 minimal monthly wages within three months of the same
becoming due. In addition, the First Law required the creditor to send
to the debtor a last-minute warning to the effect that the creditor
would file an insolvency petition if the debtor failed to pay its debt
within seven days of the date of the warning.
The major flaw of the First Law, from the perspective of the debtor,
was that it did not relieve the debtor from interest, fines and penalties
accruing during insolvency proceedings in relation to the debtors breach
of its obligations. Thus, while the moratorium imposed during insolvency
proceedings would prevent the creditors from collecting their debts, it
would not stop interest/penalties/fines from accruing. As a result, even
where debtors were able to qualify for external management or rehabilitation proceedings (and thus, initially avoid liquidation), most of them
still ended up in liquidation immediately after the termination of the
initial proceedings since, once the moratorium ended, debtors would find
84
themselves unable to meet their liabilities in respect of the interest, fines

and penalties that had accrued during the insolvency proceedings.
With time it became apparent that the First Law did not serve its
purpose of restructuring inefficient businesses as it did not give
debtors sufficient opportunity to recover. The number of bankruptcy
cases was relatively small (eg in 1993, the courts completed 74 cases
and in 1994, 231 cases) and did not match the level of nonpayments/defaults in the economy.
The tough monetary policy of the Government and the Central Bank
led to a lack of cashflow in the economy: the so-called crisis of nonpayments. Cash settlements were rare and businesses preferred to
settle debts between themselves and even with the State via barter,
set-off, promissory notes and other arrangements not requiring cash
payments. These arrangements were often associated with creative tax
planning. The President tried to remedy the situation and on 18 June
1996 adopted the famous Decree No. 1212, which prohibited, among
other things, debtors with outstanding tax obligations from having
more than one bank account. Many Russian businessmen, however,
preferred not to use any bank accounts at all rather than see their
money being interfered with by the tax authorities. It became apparent
that where the State was not able to change a businesss practices, it
would need to create a mechanism to change the management and the
ownership of troubled entities by modernizing insolvency legislation.
The second bankruptcy law

On 8 January 1998, Federal Law No. 6-FZ the Law on Insolvency
(Bankruptcy) (the Second Law) was adopted. The Second Law was
intended to make insolvency proceedings easily accessible to creditors
in the hope that this would help the restructuring of troubled
companies, would replace the old management with a more efficient
one and would cope with the so-called crisis of non-payments. The
reality turned out to be very different.
The Second Law eliminated the inability to repay/inadequate
assets insolvency test for indebted legal entities, but left the test intact
for debtors who were individual entrepreneurs. An insolvency petition
could be filed by a creditor if a debtor failed to pay debts equal to or
exceeding 500 minimal monthly wages (approximately $3,000 at the
time) within three months of the same becoming due, irrespective of
the cause of the non-payment. The Arbitration Court had to review the
insolvency petition (basically, on formal grounds) within three days of
its date of filing. Insolvency proceedings were due to commence automatically following the acceptance of the insolvency petition by the
Arbitration Court. The Second Law did not require the Arbitration
Court to invite the debtor to the hearings. Later the Constitutional
85
Court acknowledged such practice to be unconstitutional, but that was

long after the initiation of the most famous insolvency proceedings
Imperial Bank and Inkombank.
Once the Arbitration Court accepted the insolvency petition, it was
obliged to appoint a temporary manager who would identify the state
of the debtors financial affairs, take measures to preserve its assets,
identify its creditors and convene the first creditors meeting. The creditors meeting would then decide whether to petition the court to
liquidate the debtor (if the debtor was hopelessly in debt) or to put it
into so-called external management (if the debtor had a chance of
recovering). The creditors could also enter into an amicable settlement
with the debtor.
The arbitration managers (temporary managers, external managers
and liquidators) were meant to be independent licensed professionals
who would protect the creditors and play a key role during insolvency
proceedings. This was quite a challenging role for a newly-created
profession. The Second Law provided for a transitional period during
which no licences were required and the functions of the arbitration
managers could be performed by so-called anti-crisis managers. In
practice, this meant that virtually any man off the street could become
an arbitration manager by completing a one-month course and passing
a simple test. Clearly, this was not always enough to prepare a
manager to cope with the insolvent entities, many of which were giant
companies or some of the largest Russian banks, run by huge
management teams.
The draftsmen of the Second Law did not take into account the
possibility that arbitration managers and the Arbitration Court could
be serving the interests of people other than the creditors. The Second
Law created a solid basis for abuse: it lacked any system of checks and
balances, it did not differentiate between independent creditors and
affiliates of the debtor, it excluded the shareholders/participants of the
debtor and its management from the insolvency proceedings, it limited
the role of the creditors and created a fairly poor mechanism for supervising the activities of arbitration managers. It was not surprising then
that the Second Law became a popular mechanism for ruining and
taking over the business of a competitor, cheating creditors and the
State. The Second Law well deserved its reputation as the Russian
Federation law that did more than any other to promote the development of corruption.
Following the adoption of the Second Law, the number of insolvency
cases snowballed year by year. While initially one could argue that the
increasing number of insolvency cases was due to the August 1998
financial crisis caused by the collapse of the Russian GKO market,
later it turned out that the growth in the number of insolvencies
continued for years after the crisis (see Table 2.3.1).
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Table 2.3.1 Insolvency statistics

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
Number of
petitions
filed
Number of
cases
completed
74
231
Backlog
* 19,041 47,762 55,934 106,647
716 1,226 2,269 2,628

*
2002
5,959 10,485 18,993 44,424
* 13,082 50,359 87,300 102,820
*No data available
While the Second Law envisaged that it was the specific duty of the
temporary manager to identify the debtors creditors and while the
creditors had the right to file their claims (eg if for some reason their
claims were not properly identified by the temporary manager), the
Second Law was interpreted and applied in such a way that creditors
wishing to participate in insolvency proceedings and to be entitled to
repayment, had to file their claims (together with the relevant
supporting documents) with the debtor in order to establish their
claims, irrespective of whether the debtor and the temporary
manager knew or should have known about the relevant creditor and
the amount owed to it (except for claims confirmed by the court
decision). The debtor had seven days to object to the claim. The failure
to object meant that the claim was established and should be
included in the register of claims. In practice, temporary managers
often raised objections or refused to enter the relevant claim in the
register even where the debtor did not object to or even acknowledge
the claim.
Cases of disputed claims had to be resolved by the Arbitration Court.
The Second Law neither required the debtor to have sufficient grounds
for objections, nor provided for any sanction for frivolous objections
being made to creditors claims either by the debtor or by the
temporary manager. As a result, the courts were inundated with
disputed claims. The hearings of such claims would typically take just
a few minutes and, what was still more frustrating, the relevant court
resolutions on the establishment or dismissal of the claims were not
subject to appeal. One could only imagine a creditors reaction and the
impact this had on an investors confidence where the validity of multimillion dollar claims depended on the outcome of a brief hearing, which
was often little more than a formality. Later, the Constitutional Court
acknowledged such practice to be unconstitutional, but for many creditors/insolvency cases it was already too late.
87
Insolvencies of credit organizations

Dissatisfied that its role had been downgraded to the position of a mere
creditor, the Central Bank lobbied for the adoption of Law No. 40-FZ
the Law on the Insolvency (Bankruptcy) of Credit Organizations of 25
February 1999 (the Banks Insolvency Law), which put the Central
Bank back in a position to control insolvency proceedings of banks and
other credit organizations (eg the Central Bank became entitled to
impose additional qualification requirements on arbitration managers
of credit organizations and to issue special certificates to them).
In line with the First Law, the Banks Insolvency Law provides that
insolvency proceedings can be initiated against a bank only after revocation of its banking licence by the Central Bank. Taking into account
the fact that after revocation of its banking licence the former bank
cannot conduct banking business and, thus, cannot recover, the
outcome of the the Banks Insolvency Law is that the system of external
management does not apply to banks, ie if a bank becomes insolvent it
should be liquidated. For some reason the Banks Insolvency Law also
prohibits bankrupt banks from entering into amicable settlements
with their creditors.
On 8 July 1999, Federal Law of Russia No. 144-FZ, The Law on
Restructuring of Credit Organizations, was adopted. This law envisages
various insolvency prevention measures that can be taken in relation to
a bank and also deals with the rehabilitation of banks by the state
Agency for Restructuring of Credit Organizations (ARCO). The procedures envisaged by this law effectively serve the same purpose as
external management and financial rehabilitation (see below) procedures serve in relation to corporate debtors. If none of these measures
work, the Central Bank would revoke the debtors banking licence and
would effectively put it into liquidation in accordance with the procedure
envisaged by the Banks Insolvency Law. The press reports that ARCO
will soon be liquidated as it has already performed its purposes,
therefore the relevant legislation will be amended accordingly.
Natural monopolies
Astonished by the scale of criminal activities arising from the Second
Law, the legislature rushed to protect Russian corporate monopolies
and on 24 June 1999 adopted Law No. 122-FZ, the Law on Specifics of
the Insolvency (Bankruptcy) of the Subjects of Natural Monopolies in
the Fuel and Energy Complex (the Natural Monopolies Law), which
increased the minimum level of indebtedness required in order to file
an insolvency petition by a thousand times, reverted back to the
inability to repay/inadequate assets insolvency test and introduced
special qualification requirements for arbitration managers. It is not
surprising that this law has rarely, if ever, been tested in practice.
88
Current status
On 26 October 2002, the President of the Russian Federation signed
the new Law on Insolvency (Bankruptcy) (the Insolvency Law). The
Insolvency Law came into force (with some exceptions) on 28
November 2002.
The Insolvency Law replaced the Second Law as well as the Natural
Monopolies Law. However, it still envisages that the insolvency of banks
will be subject to a separate legal regime. Thus, both the Banks
Insolvency Law and the Law on Restructuring of Credit Organizations
continue to apply. The press has reported that the Banks Insolvency
Law will be significantly amended soon, presumably in connection with
the introduction of a system for insuring private deposits in banks.
The scope of the Insolvency Law has been extended. It now applies
(with some exceptions) not only to commercial legal entities but to noncommercial legal entities as well (such as state corporations, public
organizations, non-commercial partners, and autonomous noncommercial organizations and condominiums (partnerships of owners
of apartments)). It also now applies to natural monopolies (including
nuclear power stations, which were previously exempt from insolvency
proceedings).
The Insolvency Law was drafted with the primary purpose of
preventing the numerous abuses that occurred on the basis of the
Second Law. To this end the Insolvency Law:
makes it more difficult to initiate insolvency proceedings, ie an
insolvency petition can be filed against a debtor only if its indebtedness is confirmed by a court judgement that has come into force
(in case of civil law claims) or by a decision of the relevant tax or
customs authority on the levy of enforcement over the debtors
assets (in case of tax claims); and such indebtedness is not satisfied
within 30 days after the submission of the writ of execution to the
bailiff (in the case of civil law claims) or after the relevant decision of
the relevant tax or custom authority on the levy of enforcement over
the debtors assets (in case of tax claims);
gives the debtor, its shareholders/participants/owners and the state
authorities a greater say in insolvency proceedings, eg both the debtor
and its shareholders/participants/owners can now officially participate (though with no voting rights) in insolvency proceedings, and
the state authorities (eg tax/customs/municipalities) have equal
status with other creditors and can vote at each creditors meeting and
not just at the first meeting, as was the case under the Second Law;
increases state and public control over arbitration managers, eg the
qualification requirements for arbitration managers have been
89
tightened, the creditors can introduce certain further qualification

requirements for the arbitration managers, and the procedure for
the appointment of arbitration managers has been complicated and
now resembles to a degree the jury selection process;
introduces various measures to avoid abuse of process, eg all claims
are established by the court only. The arbitration manager or the
creditors can elect to transfer the function of keeping the register of
creditors claims to an independent registrar, and the arbitration
manager no longer has the authority to manage the debtor during
the supervision stage even where the head of the debtors executive
has been removed by the court a tactic often used in the past to
gain complete control over the debtor.
Along with closing the loopholes in the Second Law, the Insolvency
Law introduces various further changes with a view to improving the
efficiency and outcome of insolvency proceedings. For example, the
Insolvency Law:
introduces (in addition to supervision, external management and
liquidation) a new stage of insolvency proceedings, namely, financial
rehabilitation, whereby either the debtors shareholders/participants/
owners or the state authorities or third parties may guarantee and
procure the performance of all the debtors obligations in full;
specifically authorizes the debtor to issue additional shares (by
closed subscription) in order to repay its debts;
has reduced the number of classes of ranked claims from five to
three. More importantly, is that it has improved the position of
secured creditors, ie claims secured by a mortgage/pledge are
satisfied in priority to all other claims except for claims of first
(claims for harm caused to health or life) and second (salaries,
severance and copyright payments) priority arising prior to the
creation of the pledge. This is in contrast to the position under the
Second Law whereby the claims of secured creditors were satisfied
after all claims of first and second priority, irrespective of when they
had arisen. In addition, the Insolvency Law clarified that secured
creditors claims be satisfied in priority to unsecured claims out of
the value realized upon the sale of the pledged/mortgaged assets
rather than from the pooled property of all secured creditors and
potentially all property of the debtor.
On paper, the Insolvency Law constitutes a significant improvement
in the Russian legal environment. There is no doubt that it will stop
many of the abuses conducted on the basis of the Second Law.
However, it remains to be seen whether it will be widely used in
practice as a civilized way of dealing with insolvencies, or whether it
90
will go the way of the Natural Monopolies Law, which was not used
due to the complexity of initiating insolvency proceedings. The
absence of any significant reported bankruptcy cases (except for the
potential bankruptcy of Yukos) initiated under the Insolvency Law
during the past two years supports the second premise.
2.4
The Issuance and

Regulation of Securities
Max Gutbrod, Partner, Baker & McKenzie
CIS, Limited
Introduction
Generally, the securities markets and securities transactions are regulated by the Russian Federal Law on the Securities Market (the
Securities Law), enacted 22 April 1996. The offering of corporate securities is regulated by the Law on Joint Stock Companies (the JSC Law),
enacted on 26 December 1995, and to some extent by the Law on
Limited Liability Companies (the LLC Law), enacted 8 February 1998,
and by the Law on Banks and Banking, enacted 2 December 1990
(regarding credit institutions).
During the last few years, there has been a fair amount of discussion
on changes to the applicable legislation and on the structure of the securities markets in general. To date, this has resulted only in a new
Federal Law on Mortgage-Backed Securities (the MBS Law), which
came into effect on 18 November 2003, introducing two new types of
securities, namely mortgage-backed bonds and mortgage participation
certificates.
Only open JSCs can issue publicly-traded shares. Russian securities
are also subject to a number of regulations issued by the FSFM (previously, the FCSM), the Russian Civil Code, and the regulations issued
by other regulatory agencies.
The stock exchange

In Russia, there are several well-established stock exchanges, both in
Moscow and throughout the Federation. Stock exchanges are governed
by regulations of the FSFM (previously, the FCSM), and other governmental bodies. However, only a small percentage of transactions occur
92
on the stock exchanges. Most sales of securities in the Russian

Federation are executed over the counter (OTC) between licensed
brokers and investors. Procedures for obtaining a licence to carry out
broker/dealer activities and requirements for potential brokers/dealers
are set forth in regulations adopted by the FCSM.
There has been a fair amount of discussion on the role of stock
exchanges over the last few years, which has resulted in an expectation
that requirements for listing are likely to be tightened soon.
Corporate securities
Russian JSCs may issue shares, options on shares, corporate bonds,
and other securities authorized by the Russian Civil Code and the
FSFM. Open JSCs may raise capital either by issuing shares to the
public or by private placement. Shares of closed JSCs may not be
offered to the general public.
Securities in general
Unless a particular instrument is specifically recognized by law as
being a security, it will not be considered to be a security. Article 143 of
the Russian Civil Code provides a list of recognized securities. These
securities include bonds, shares, negotiable promissory notes, cheques,
deposit and saving certificates, bills of lading, and securities issued in
the process of privatization. In addition, option certificates have been
included within the Russian legal definition of securities.
The Securities Law outlines the procedure for the registration of
securities issuances and clarifies when a prospectus is required. A
prospectus is required when either:
1. securities are to be distributed to an unlimited number of holders; or
2. the number of holders is known and exceeds 500; or
3. securities are intended to be listed or otherwise publicly traded.
The Securities Law generally requires quarterly reporting of financial
and other information and the publication of information describing
material events that will affect the finances or the business activities
of the issuer within five days after the occurrence of such events.
Issuers must provide such information if they have ever registered a
prospectus or if they are issuers of publicly offered securities.
The Issuance and Regulation of Securities
93
Regulation of the securities market

The Federal Service for the Financial Markets (FSFM)
Pursuant to Presidential Decree No. 314, dated 11 March 2004, the
FSFM has replaced the Federal Commission for the Securities Market
(the FCSM) as the primary regulator of the Russian securities market.
The FSFM functions, which it carries out either directly or through its
pre-authorized agencies, include the licensing and supervision of
professional securities-market participants, the authorization of selfregulatory organizations, the registration of securities issuances and
prospectuses and the approval of standards therefor, and the classification and definition of different types of securities.
The FSFM has the authority to take certain actions against professional securities-market participants who violate the securities regulations. These measures include the suspension and revocation of
licences, enforcement actions, and petitions for criminal prosecution.
In addition, the FSFM has the power to fine legal entities or individual
entrepreneurs for various securities law violations. Any action pursued
against issuers, such as the invalidation of an issuance, must be
effected through the courts. Consequently, the ultimate jurisdiction
over breaches of the securities laws remains with the courts.
Self-regulating organizations (SROs)

The requirement of obligatory membership in an SRO for professional
participants in the securities market was repealed by the Presidential
Decree of 16 October 2000. Pursuant to a FCSM press release dated 23
October 2000, professional participants may now apply directly to the
FSFM to receive a licence. According to the Licensing Regulation, the
FSFM must make a decision on issuing a licence to an applicant within
30 days of a direct submission of the documents to the FSFM or within
15 days if an applicant presents a recommendation from an SRO along
with the documents. Since the requirement that an SRO recommendation be received prior to the licensing still exists in a number of the
FSFM regulations previously adopted by the FCSM, some representatives of SROs consider an SRO membership an ongoing requirement
for receipt and possession of a licence.
Regulatory measures
The FSFM shares its regulatory authority over the securities market
with the Central Bank, the Ministry of Finance, and the Federal
Anti-Monopoly Service (the FAS). For example, the FAS regulates
trading in options and futures, while the FSFM regulates derivatives
with underlying assets.
94
The Securities Law also imposes disclosure requirements on holders

of securities and on professional securities-market participants. A
holder of an issuers securities (other than bonds non-convertible into
shares) is required to disclose its holding when such a holder possesses
20 per cent or more of the issuers securities. Moreover, as long as a
shareholders ownership continues to be above this 20 per cent
threshold, such a shareholder is required to disclose any further acquisitions of 5 per cent or more.
The Securities Law requires that notification be provided to the
FSFM of transactions whereby foreign parties acquire shares in
Russian companies, foreign ownership of which is restricted by law (eg
the gas and electricity monopolies and insurance entities). In addition,
the FSFM must approve securities issued by Russian issuers for
placement and organized trading outside of the Russian Federation.
Legislation enforced prior to the passing of the Securities Law
prohibited the use of insider information. The Securities Law provides
a somewhat more sophisticated and potentially broader definition of
insider trading. The legislation refers to the utilization and passing of
inside information for use where the information was gained by virtue
of office, job position or contract.
Bonds
The issuance of corporate bonds is regulated by the Russian Civil Code,
the JSC Law, and the LLC Law. The public issuance and trading of
bonds is governed by the Securities Law.
The above Laws introduced the concept of secured and unsecured
bonds. Secured bonds must be fully secured with a third-party guarantee or suretyship, or with a pledge (or a mortgage) of the issuers
and/or third partys securities or immovable property. Only companies,
including credit institutions, that have existed for a minimum of three
years may issue unsecured bonds. The above Laws provide that the par
value of all unsecured bonds issued by a company must not exceed the
charter capital of the company and that no bonds may be issued until
the charter capital is fully contributed.
In April 2002, a new FCSM resolution providing, inter alia, for standards applicable to the issuance of bonds convertible into shares was
adopted. These new Standards of Issuance set forth more detailed
procedures for the issuance of bonds convertible into shares and
further developed some relevant provisions of the JSC Law.
2.5
Currency regulations
Vladimir Dragunov, Partner, Baker &
McKenzie CIS, Limited
Introduction
Article 140 of the Russian Civil Code declares that the rouble is the
national currency of the Russian Federation. Although agreements
may refer to the rouble value equivalent of foreign currency, all transactions conducted inside the Russian Federation, as a general rule,
must be settled in roubles. Article 317 (3) of the Civil Code, however,
permits the use of foreign currency in cases provided for by law.
The main piece of federal legislation regulating currency transactions is the Law on Currency Regulation and Currency Control (the
Currency Law) of 9 October 1992. The Currency Law governs foreign
currency transactions, such as the transfer of ownership or other
rights to foreign currency. The Currency Law also regulates the powers
of currency control agencies and the rights and duties of individuals
and legal entities to possess, use and dispose of currency valuables,
and imposes liability for the violation of currency legislation. Currency
valuables include foreign currencies, securities in foreign currencies,
precious metals, and precious stones.
On 17 June 2004, the Currency Law will be replaced with the new
Federal Law No. 173-FZ, On Currency Regulation and Currency
Control (the New Currency Law), dated 10 December 2003. It is
expected that in the meantime certain implementing regulations will
be adopted by the Russian Government (the Government) and the
Central Bank of Russia (the CBR). The New Currency Law is an
important step in the process of removing most of the currency control
restrictions, which is expected to occur in 2007.
Foreign investors must monitor currency regulations very carefully
since these rules change frequently in the Russian Federation. In light
of the high penalties for failing to observe the Currency Law, foreign
investors should seek the most up-to-date legal advice to ensure that
they are in compliance with all Russian currency requirements.
96
Resident vs non-resident status

The Currency Law gives the CBR authority to regulate the possession
and use of foreign currency by individuals and legal entities on the
territory of the Russian Federation. The Currency Law divides individuals and legal persons into two groups: residents and non-residents.
Residents include Russian citizens and other individuals whose
permanent place of residence is the Russian Federation, legal entities
created in accordance with Russian legislation, representative offices
(branches) of Russian legal entities outside of Russia, and
enterprises/organizations that are not legal entities but are located inside
the Russian Federation. Non-residents are defined as individuals whose
permanent place of residence is located outside of Russia, legal entities
incorporated outside Russia, and representative offices (branches) of
foreign legal entities in Russia. The distinction between residents and
non-residents is retained in the New Currency Law with minor changes.
Bank accounts
A non-resident company may open the following types of accounts in
the Russian Federation:
rouble convertible account (K account);
a rouble non-convertible account (N account);
a foreign currency account; and
a special purpose rouble account for state-issued securities and
certain blue chip corporate securities issued by Russian companies
(S account).
A non-resident company can open any of the above accounts regardless
of whether it is accredited to do business in Russia or not. Certain
restraints are imposed on N accounts and S accounts. Funds from N
accounts, for example, may be used for the purchase of foreign currency
not earlier than 365 days after presenting a purchase order to an
authorized bank. Cash withdrawals from both K and N accounts may
be effected only for the purposes authorized by the CBR, while cash
withdrawals from S accounts are prohibited.
The New Currency Law does not expressly provide for such limitations. However, it remains to be seen whether the limitations existing
under the current currency regime will continue after 17 June 2004.
Movement of capital
The Currency Law divides foreign currency transactions into two
categories: capital movement currency transactions and current
Currency Regulations
97
currency transactions. Capital movement currency transactions

include:
direct investments;
portfolio investments, ie the acquisition of securities;
money transfers to pay for the title to buildings, real estate, land,
and other property;
grant or receipt of a payment deferment of more than 90 days for the
import and export of goods; and
extension or receipt of financial credit (loans) for more than 180 days.
Capital movement currency transactions must be carried out pursuant
to a CBR authorization for which only resident legal entities can apply,
unless otherwise exempted by the CBR. Examples of such exemptions,
which are conditional upon satisfying certain requirements, include,
among others:
foreign currency transfers by resident individuals to and from
Russia in amounts not exceeding US$75,000 during the course of a
calendar year in order to acquire foreign currency denominated
securities or to exercise rights in such securities;
loans from non-resident entities; and
transfers of currency by non-residents to resident entities under
Russian real estate sale or lease contracts.
Current currency transactions do not require a CBR authorization.
Such transactions include:
foreign currency transfers to and from the Russian Federation making
immediate settlements of payments for import and export of goods;
settlements connected with credits granted for not more than 90
days for import-export transactions;
extension or receipt of financial credits (loans) (not to exceed 180
days);
transfers to and from the Russian Federation of interest payments,
dividends, investments, credits, and other transactions linked to the
movement of capital; and
transfers of a non-commercial nature, including the transfer of
wages and salaries, pensions, alimony, business trips expenses,
inheritances, and other similar transactions.
The New Currency Law abolishes the distinction between current
transactions and capital movement transactions. The New Currency
Law will also substantially limit the authority of the CBR to restrict
98
currency operations in Russia. Firstly, it provides for an exhaustive list

of currency operations subject to administrative regulation and establishes a free hands regime with respect to other currency operations
between residents and non-residents. Further, it limits the list of regulators to the CBR and the Government of the Russian Federation and
clearly states that these bodies may not introduce new requirements to
the currency regime established by the New Currency Law, except as
provided by the New Currency Law itself. Finally, the New Currency
Law explicitly prohibits imposing of any requirements to obtain individual permits for a particular type of currency transaction.
Instead of individual permits and requirements, the New Currency
Law introduces new types of limitations, namely special account and
mandatory reserves. A special account should be used for conducting
certain types of foreign currency transactions. The regime for such
accounts is yet to be defined. The requirement to keep a mandatory
reserve would be imposed on residents and non-residents according to
a number of currency operations specified in the law. Residents or nonresidents thus may be required to block a certain amount of money in
roubles (up to 100 per cent of the value of the relevant currency operation as may be determined by the CBR or the Government) in a
separate non-interest-bearing account with a Russian authorized bank
for a certain period of time (eg 2, 12, and 24 months). The authorized
bank will further reserve an equivalent sum at the CBR. In most cases,
such reserves shall be established not later than the day of the
currency operation subject to a mandatory reserve. However, in certain
cases (eg purchase by non-residents of securities issued in Russia, by
residents of securities issued abroad, or by residents of participation
interest in foreign companies), residents and non-residents may be
required to establish such reserves in advance.
Liability for violation

Persons violating Russian currency regulations may be subject to civil,
administrative, and criminal liability. Administrative penalties for the
violation of Russias currency regulations are currently provided for in
Articles 15.2515.26 of the Russian Federation Code of Administrative
Offences, which entered into force on 1 July 2002. These penalties are
mainly fines that may be imposed upon different types of offenders:
individuals, officers of enterprises, and legal entities. The amounts of
fines vary from a tenth to the entire amount of profit gained as a result
of the illegal currency transaction. In addition, violators, particularly
authorized banks, can be fined for failure to submit the proper documents to the authorities and can also lose their licences to conduct
foreign currency transactions.
2.6
Corporate Governance
Development in Russia
Branan
Improvement of corporate governance is one of the prerequisites to

further successful development of the Russian economy.
It is difficult to give a precise and exhaustive definition of corporate
governance. The essence of the term is relationship between a
companys management bodies, shareholders and other interested
parties; it also encompasses the principles the company enforces to
manage and control decision-making processes and operations in
general.
The model of the corporate governance currently shaping in Russia
is in many ways different from the traditional concepts that evolved in
other countries, namely Anglo-American, German (or European) and
Japanese (or Asian) models.
The main mechanisms of functioning of the Anglo-American model
(also referred to as Shareholder Wealth Maximization Model, or SWM)
are a board of directors elected by shareholders on a one-share-onevote principle, management chosen by the directors and working
towards maximization of the companys share value, which is based
upon the present value of expected future dividends. In this model,
suppliers of equity capital, ie shareholders, bear the entire risk of the
enterprise and are residual claimants of the income.
The German or European model (also referred to as Corporate
Wealth Maximization Model, CWM) is based on the social interaction
principle: apart from shareholders, there are other groups that have a
stake in the operations of the enterprise, eg key suppliers of the
company, its personnel, as well as suppliers of debt capital (banks),
public organizations, the State, etc. The objective of management
decision-making in this case is to increase wealth and power of the
company as an entity. In this model, it is usually difficult for outsiders
to take the control away from the management, and voting power in
the governance of the corporation is usually not one-share-one-vote.
100
Two-layer management is practised with supervisory and

management boards in place where all the stakeholders are represented, cross-ownership is a frequent phenomenon, and banks often
hold substantial stakes in the companies.
The Japanese or Asian model is characterized by the great State
involvement into the companies activities, and the shaping of large
vertically and horizontally integrated groups (pyramid structures)
comprised of financial institutions, State and businesses, usually under
control by one family (keiretzu in Japan and chaebols in South Korea).
In this situation, distortions in corporate governance structure have
been inevitable, the main being immature mechanisms of interaction
between controlling and minority shareholders, conflicts of interest and
lack of transparency, which resulted in inefficiencies in companies
management partly contributing to the Asian crisis at the end of 1990s.
Corporate governance in the countries in transition, however, does
not fit precisely into any of the above models. Some experts refer to the
corporate governance model currently shaping in the transition
economies as the entrepreneurial model. Its main principle is that it has
all the recognized necessary elements of corporate governance, but none
of them work in reality, as State regulation and economic policy are
unpredictable and strongly depend on the political interests of the officials and oligarchs. The main characteristic of this model is the absence
of division of competencies and responsibilities between the owners and
the management, as well as a high degree of political and economic
uncertainty.
The current situation in Russia, in our opinion, cannot be described
using a single model. At the beginning of 2004, corporate governance
appeared to have gone beyond the entrepreneurial model and to be
approaching the European one, with social responsibility being one of
the priorities for the most advanced corporations. However, the way
the situation with the largest Russian oil company Yukos has later
developed suggests that the State is still able to exercise far greater
influence on private companies than their management bodies and
shareholders, which has thrown the Russian corporate governance
system back to the entrepreneurial model. Besides, share value
remains one of the main indicators of corporate governance effectiveness, as in the Anglo-American model. However, the State
remaining the largest Russias shareholder, and large vertically and
horizontally integrated financial and industrial groups still being in
place, the situation suggests adherence to the Asian model. Therefore,
conclusions about the character of corporate governance in the Russian
Federation should be made only on the basis of an overall analysis of
the business development of the country as a whole.
Later an historic overview and explanation of the peculiar nature of
corporate governance development in Russia will be given. In the
101
meantime, let us outline the main driving forces behind the recent
positive change in companies attitudes to corporate governance.
Firstly, the Russian companies realized the need to attract outside
capital, including foreign investment, which called for greater transparency in operations and improved corporate governance mechanisms. According to McKinsey, when evaluating companies in
transition economies, large investors normally focus more on the
quality of corporate governance rather than financial and economic
performance. Moreover, having foreign businessmen among shareholders of the company and especially on the board makes it easier for
Russian companies to enter highly-competitive international markets
and successfully operate there, as demonstrated in the findings of the
recent research by the Higher School of Economics and the Institute of
Comparative Studies.
Secondly, the effort of existing minority shareholders, especially
those represented by non-resident investors, aimed at better protection
of their rights, played its positive role in development of corporate
governance in Russia.
Thirdly, the companies realized that improved corporate governance
standards and enhanced business transparency can be used as a new
PR tool, especially if the company succeeds to reserve the first-comer
status here, which will help the company to achieve competitive edge
and shape a positive image in the opinion of the general public.
The peculiarities of corporate governance in Russia can be largely
attributed to the specifics of privatization strategies applied in Russia
in the 1990s.
Privatization in the first half of the 1990s was supposed to transfer
state-owned enterprises into companies with a broad ownership base,
as well as to ensure economic development via competition between
efficient owners and skilled managers.
Back at the end of the 1980s, under Gorbachev, employees and
managers were granted a right to lease and subsequently buy from the
State the assets of the enterprises they were working at. Later, with
the overall collapse of the administered planning system and
disruption of vertical economic links, the new Mass Privatization
Programme (MPP) was initiated, where individuals would be given
undifferentiated vouchers to be used as a bid for shares in newly privatized enterprises. In the course of MPP, over 30,000 joint-stock
companies were created. Within the programme, enterprises from
several selected strategic industries, utilities being one of them, were
made non-public with the State holding a controlling stake in them
and with the rest of the stock allocated to the insiders and
management. Thus, large well-performing companies in strategic
sectors became controlled by the State and the insiders; majority stock
at non-strategic SMEs with stable performance was acquired by the
102
management and employees; and finally shares of non-resource

companies with poor operating performance became available to the
general public in exchange for the vouchers at privatization auctions.
The main drawback of the privatization idea as a whole was that the
Russian businesses had to travel all the way from state-owned enterprises via individual firms and partnerships to the corporations, the
highest business organization form, within an extremely short period
of time, whereas it took dozens of years in other economies. Illpreparedness of the companies for corporate relations caused a
mismatch between the form and the content and resulted in numerous
conflicts of interest, creating situations running counter to the initial
goals of privatization. Some of the results of MPP were the concentration of ownership and control in the hands of the insiders and the
so-called oligarchs nurtured by government policies, as well as undervaluation of enterprise assets at privatization auctions stemming from
the absence of assessment and valuation practice and experience.
Institutional investors, who in other emerging economies would traditionally act as depositary vehicles, exercise oversight in the privatization process and act to protect minority shareholders rights, were
underdeveloped in the period of privatization and in most cases
pursued profiteering goals. Lack of legal infrastructure, blind reliance
on the Western practices often non-applicable to the Russian reality,
and the shock therapy nature of MPP exacerbated the situation.
After the MPP, until 1995, the Russian government largely retained
control over the majority of the strategic enterprises. However, due to
unfavourable political conditions and budget deficit, it consented to the
loan-for-shares programme offered to Yeltsins government by some
oligarchs. The programme implied offering low-interest loans to the
government by a consortium of the Russian banks, and conducting
cash auctions between commercial banks (mostly led by the oligarchs)
for the State shares in the strategic enterprises, which would be later
transferred to the winners as collaterals. Until the government were
able to repay the loans, the strategic enterprises would remain under
control of the auction winners; if the State failed to repay the loans, its
share would be transferred to the creditors, which eventually became
the case. Apart from transferring control to the financial industrial
groups, the government continued subsidizing them as if they
remained government enterprises. This peculiar partnership between
the government and large businesses gave way to various kinds of
abusive self-dealing and wealth expropriation from minority shareholders. The main types of the shareholder rights violation were sharedilution, asset-stripping, related party transactions, transfer pricing,
hostile bankruptcy and delayed dividend payment.
The gaps in legislation, excessively stringent tax policy and political
uncertainty created no incentives for the managers of the companies to
103
introduce and apply corporate governance principles. In the situation

of an undeveloped and illiquid secondary market, the managers were
not interested in share price increases; they were not inclined to pay
dividends, for they perceived the payments as depriving them of a part
of profits; strategic goods prices being still controlled by the State, the
managers tended to strip assets for sales abroad; they resorted to
various measures to conceal actual income, which had disastrous
effects for corporate accounts transparency. Besides, managers were
not interested in attracting outside investors and voted for restricting,
if not prohibiting, bankruptcy procedures, so preventing restructuring
of loss-generating companies.
Paradoxically, the crisis of 1998 had a positive overall effect on the
ownership structure of the financial industrial groups: to avoid
bankruptcy, many of the holdings and the banks sold their stakes in
underperforming or illiquid assets. As a result, the number of
management and employee holdings decreased while the number of
outsider holdings, as well as non-financial firms, company holdings
and largely unaffiliated banks, rose. An increase in foreign and individual investment was a sign of increased diversification of the
ownership base, too. This increase in investment came largely as a
result of the actions of the large business group owners, who had been
initially busy with acquiring, retaining and restructuring assets, but
now finished assets consolidation and became interested in raising
funds from outside sources.
Another important development of the period was the emergence of
institutions dealing with shareholders rights protection, such as the
Investor Protection Association, the Investor Protection Program of the
National Association of the Professional Participants of the Securities
Market, the Institute for Corporate Law and Governance, etc.
However, the management of most of the Russian companies still
had an upper hand in the disputes, as compared to the minority shareholders. The situation with Yukos, which in 1998 became subject to
greenmail by notorious US investor Kenneth Dart, is a good illustration for the point. Having a minority stake in the company and
being aware of the upcoming acquisition by Yukos of its several
subsidiaries, Dart decided to block the management decision and
negotiate with Yukos management to sell his shares in the companies
at extremely high prices. However, the management took a decision to
conduct an additional issue of shares of subsidiaries, thus diluting
Darts stake and depriving him of the blocking right. On the one hand,
the situation could be regarded as shareholder rights violation; on the
other hand, it could be viewed as clearly obstructing the introduction
of corporate governance principles, namely the transition to single
shares that Yukos was to undertake. The conflict lasted for almost two
years and despite a controversial public attitude and the clearly
104
negative effect on the companys image, the decision was never

revoked.
Several new laws were adopted during 19972001, mainly focusing
on information disclosure, shareholders rights protection, specifics of
the management bodies (Board of Directors, Revision Commission, and
Management Board), and improvement of auditing and accounting
standards. The New Tax Code with lower tax rates and mechanisms of
prevention of minority shareholders rights violations was adopted. A
new bankruptcy law and the new Code of Arbitration Procedures, for
instance, had clauses protecting the rights of majority shareholders,
which, paradoxically, have also been an issue in Russia; with improved
legislation it became more difficult to initiate and conduct hostile
takeovers via bankruptcy and share seizure.
Greater government involvement was observed: functions of the
Federal Commission on Securities Market (FSCM) were expanded; a
Co-ordination Council for Corporate Governance was set up within it
in 2000. Later, in 2003, the National Council for Corporate Governance
(NSKU) was established at the initiative of the Russian Union of
Industrialists and Entrepreneurs (RSPP), Chamber of Commerce and
Industry (CCI), and the FSCM. The council includes leading businessmen and representatives of government and other agencies.
In 2001, the Federal Commission for Securities Markets started to
work on Russias first Corporate Governance Code, which was introduced in April 2002. The Code does not have a status of a law; it is
rather a set of recommendations describing best practices of corporate
governance. In 20012002, several large Russian companies (Gazprom,
RAO UES, Yukos, Sberbank, and Magnitogorsk Iron & Steel)
developed proprietary corporate governance codes. According to 2003
research by International Finance Corporation, 20 per cent of the large
Russian companies have a Corporate Governance Code or are in the
process of approving one; 30 per cent began to draft the Code, and 35
per cent are planning to have one in the future.
Summarizing the main stages of corporate governance development
in Russian companies, it can be said that the initial step was enabling
the management to exercise control, have information on the cost and
income structure and carry out uniform policy towards all the parts of
the holdings. The second step was to carry out transition of all the
companies of the group to a single share, a lengthy and cumbersome
process involving radical changes in legal and property structure. After,
and sometimes in parallel with, the process, delegation of powers from
owners to professional managers started to take place, even though
almost all the managers previously had had some relationship with the
owners and could not be considered hired managers in the strict sense
of the term. With the delegation of powers, transition to modern standards of corporate governance started, with more transparency in
105
reporting on companies activities, Western standards are steadily being

adopted and in-house corporate codes are being developed. Some
companies, eg Yukos, have created extra incentives for top and middle
management, such as a system of options similar to that used in the US.
Many large companies, such as Lukoil and INTERROS, have incorporated the principle of accountability and social responsibility in their
corporate strategies.
In a nutshell, the period of 19972003 saw some tangible improvements in the corporate governance practices of the Russian companies.
The specific areas where the changes occurred were in the composition
of the Board of Directors (greater shareholders empowerment took
place with an increased number of minority shareholders and independent directors on the Boards of Directors); dividend policy (dividends have increased, clear-cut schemes of their payment were
developed); information disclosure (international and US accounting
standards started to be adopted in many large companies, at the same
time patterns of constant communication with shareholders and
analysts were developed and maintained); investor advocacy groups
(several cases of successful recourse under the law were observed).
However, the challenges still remain, among them weak law
enforcement mechanisms with corruption and illegal means of
disputes resolution still widely used, and lack of transparency and
accountability, especially in the large government-owned enterprises.
Some companies prefer to conceal the real results of their financial
performance so as not to attract extra attention on the part of the state
authorities, especially in the light of recent events concerning large
industrialists. Therefore, minority shareholders non-affiliated with the
management often do not receive real information on the companys
operations.
The taxation system in Russia still leaves much to be desired from
the corporate viewpoint: eg dominant owners still consider dividends a
waste of money in a way, due to the additional tax payments.
Administrative barriers, too, remain a very effective method of
afflicting companies, with no real market for land, estate and
communal services established yet.
Despite the fact that many large Russian companies have made
steps towards improved corporate governance practices or at least
have claimed to do so, numerous cases of discrepancies between the
norms of the corporate governance codes and companies bylaws and
their practical application still exist. For instance, distortions in the
composition of management bodies are in place, with no truly independent directors present on most of the boards.
Ownership concentration is still very high, with the State remaining
the largest shareholder, and there is still a lack of large institutional
and strategic investors, especially foreign. The risks associated with
106
the unpredictable political situation, especially in terms of the relationship between the State and large businesses, well illustrated by
the Yukos case, create disincentives for large overseas investors, which
impedes Russias further integration into the world economy.
In general, Russian business has two possible routes to globalization. The first is simply utilizing Russias natural advantages and
exporting raw materials and agricultural produce; it certainly requires
less time and effort on the companies part. The second implies a stepby-step integration of the country into the global economy in every
aspect, including corporate culture, and, despite being laborious and
time-consuming, in the long term appears more productive and
welfare-creating. Therefore, adherence to best practice in corporate
governance by Russian companies can be viewed as one of the powerful
instruments for Russian integration into the world economy.
Part Three
Market Potential
3.1
Russian Oil and Gas

Bill Page and Mark Redhead, Deloitte
Russia continues to provide both domestic and foreign investors with

tremendous opportunities in the oil and gas sector. The drive to
replace reserves and to seek alternatives to Middle East crude,
coupled with the burgeoning markets of China and South East Asia,
continue to make Russia, with its vast reserves of oil and gas, a
magnet for the oil and gas industry, as illustrated by BPs decision to
form its joint venture with TNK, formally launched on 1 September
2003. The events of the past 12 months have, however, reminded us
that with these opportunities comes risk. The Yukos affair has highlighted the political risks of doing business in Russia, whilst the
continuing delay in developing new export routes poses a threat to
planned production growth.
As of 1 January 2004, market indicators were highly encouraging:
crude production rose 11 per cent in 2003, and the reserve replacement
was around 85 per cent for oil, with new gas finds almost twice the level
of production.1 This was attributable to a general recovery from the
endemic slump that gripped the sector in the 1990s (production growth
of 38 per cent over the past five years), aided by consistently high crude
prices, benefits from rouble devaluation, relative political stability and
the application of new technology. On the other hand, production is still
significantly less than during the late 1980s. Also, the temporary
cessation of Iraqi supplies had opened up new markets in the
Mediterranean. However, the gap between domestic prices and export
ones evidenced a structurally oversupplied market with export supply
bottlenecks and administrative barriers on export trade. Transneft, the
state-owned pipeline operator, is to be commended for managing to
accommodate around 2 million barrels per day (bpd) production
growth between 1999 and 2002; however prices rose accordingly, with
per-barrel transportation costs for major Russian oils averaging
around $7 per barrel in 2003. Bottlenecking was also evidenced by the
amount of crude being transported by train and river (around 4.5
1
All figures from Renaissance Capitals Russia Oil and Gas Yearbook, 18 July 2003.
110
Market Potential
million bpd in 2003), although this costs around three times as much as
pipeline freight. A table of the 2003 results of the biggest six companies
in production terms is provided in Table 3.1.1.
Table 3.1.1 Oil production in 20022003, in thousands of barrels per
day
Company
Yukos
LUKoil
Surgutneftegaz
TNK
Sibneft
Tatneft
Jan-Dec 2002
Jan-Dec2003
% Increase
year-on-year
1,398
1,510
984
750
527
492
1,615
1,578
1,081
859
628
493
15.5
4.5
9.8
14.6
19.2
0.2
Source: Aton Capital, company data
Figures remained encouraging on the face of things as of 1 July 2004:

crude production rose 10.5 per cent year-on-year in the first half of
2004, with exports (via Transneft) up 22 per cent.
Although the situation may appear promising, with analysis
suggesting 7.4 per cent growth in 2004 overall,2 concerns have been
expressed about several issues threatening the prosperity of the sector
as a whole. Two of the reasons previously given for Russias good
performance: the devalued rouble and political stability, are now questionable. The picture is also darkened by uncertainties about the
transport infrastructure and recent changes to the tax legislation.
However, on the positive side, oil prices look set to remain strong with
predicted benchmark Brent prices of around $25.50 per barrel
predicted for 2004,3 and some analysts predicting that prices could
even touch $50 per barrel on the back of recent record highs. One indicator of the current strength of the sector is the westward movement of
Russian oil majors to operation in North America. In January 2004
LUKoil purchased 795 gas stations from ConocoPhillips, doubling its
market share in the US Northeast,4 and in-country investment in fixed
assets is also on the rise, up 13 per cent year-on-year in the first half of
2004.
However, high oil prices, combined with the dependency of the
exchange value of the rouble on these prices, could be drawing the
sector into something of a vicious circle. The problem is that many of
2
Aton Capitals Russian Oil and Gas Outlook 2004, 20 January 2004.
4
See LUKoil Doubles Share of Stations in US, Moscow Times, 28 January 2004.
3
Russian Oil and Gas
111
the oil majors revenues are measured in dollars, with a high

proportion of costs measured in roubles, therefore any rise in prices
would cause a strengthening of the rouble and corresponding undermining of profitability. Conversely, a fall in prices would mean lower
revenues, without the converse benefit from a falling rouble, as it is
believed that the rouble would remain strong even at oil prices below
$25 per barrel.5 Some companies are more at risk from a strong rouble
than others, with Yukos, Surgutneftegaz and Tatneft particularly
vulnerable.6
The arrest of Yukos CEO Mikhail Khodorkovsky in October 2003,
following the arrest earlier in the year of his associate Platon Lebedev
and seizure of a 42.1 per cent stake in the company, set alarm bells
ringing amongst investors, with the question being raised of whether
property rights were under threat. Russias equity risk premium rose
by 54 basis points to 5.8 per cent in July 2003 alone.7 When it became
clear that the bailiffs were moving in on Yuganskneftegaz, one of
Yukoss major subsidiaries, the stock exchange fell from 606 to 518
points in the space of eight days. On reflection it is clear that this was a
matter uniquely concerning Khodorkovsky and his associates and his
political aspirations; after all, had the Kremlin wished to attack other
oil companies a pretext to do so could easily have been found. However,
the broadly discussed intention of the Government to sell
Yuganskneftegaz (Yukoss main production entity) poses a vital
question as to whether the biggest Russian oil producing company may
become bankrupt as a result of a tax offence. Recently Yukos was
presented with a tax bills for the year 2000 to the amount of $3.4
billion, and this debt may grow as a result of further tax inspection.
Doubt also surrounds the pipeline system. Investment has been
made in recent years (in 20002003, 23 new pumping stations and
1,030 km of new pipelines were put into operation), and the de-bottlenecking process is ongoing, with the elimination of problems in
Novorossiysk for example. However, Transneft has simply been unable
to keep up with sector growth, as is shown by the fact that in January
2004, with production hitting a post-Soviet high of 8.94 million bpd,
exports actually fell five per cent. Inclement weather at the Black Sea
ports was blamed, raising fears of a domestic glut.8 This underlined the
fact that transportation could act as a brake on future growth. Future
expansion plans are outlined in Figure 3.1.1.
It is estimated that the pipeline/combined ratio (that between pipeline
transport and rail/river freight) can only be changed through major
5
Ibid.
7
Renaissance Capital, Russian Oil and Gas: Gauging Risk, 21 July 2003.
8
See January Oil Output at Post-Soviet High, Moscow Times, 3 February 2004.
6
112
Market Potential
Current Transneft Capacity
Existing Bypassing Systems
Pivdenniy (2003)
Novorossiysk De-Bottlenecking/Expansion (2003)

Tuapse Shift to Urals (2003)
Phase II BPS (2003)
Butinge Expansion (2004)
Adria (2004)
Other De-Bottlenecking (2004)
Phase II BPS (2004)
Additional Bypassing Systems (Ongoing)
China (2005?)
Further Adria Expansion (2006?)
Murmansk (2007?)
China Expansion (2010?)
Nakhodka (2012?)
Forecast Total Capacity
10
The Additional Bypassing Systems caption overlooks Sakhalin projects, where we estimate
crude production could approach 25 mtpa by the end of the decade. As offshore projects,
these will not rely on core shared transportation infrastructure to reach export markets.
Source: Transneft, Ministry of Energy, Petroleum Argus FSU Energy, Nefte Compass,
CERA, Renaissance Capital
Figure 3.1.1 Forecast expansion of non-CIS crude export capacity

(million bpd)
projects such as the proposed pipeline from Western Siberia to
Murmansk, from Siberia to Nakhodka (near Vladivostok) or to China
(which of the two proposed Eastern routes will be constructed remains to
be seen). As evidence of this, in January 2004 Yukos made a deal with
Russian railways for transportation of 12,000 tons per day of crude to
China, pending future potential pipeline construction which will do away
with the need for rail freight.9 To complicate matters, the railway system
is also nearing capacity on some lines (eg along the Trans-Siberian).
Transportation problems will hurt those companies with the highest
rates of growth (ie Yukos, Sibneft, TNK-BP) the hardest, as infrastructure
will be unable to keep up with their planned production increases.
Another question mark regarding the future concerns a forthcoming
update of the tax legislation. The current regime dates from 2001, and is
somewhat regressive in nature. It has not, however, successfully
captured the economic rent generated by a period of prolonged high oil
9
See RZD Rides China Oil Boom, Moscow Times, 26 January 2004
Russian Oil and Gas
113
prices in the opinion of many observers. President Putin has repeatedly

called for increases in taxation of the oil majors, and new legislation
looks inevitable, barring an unexpected sudden fall in prices. The
Energy Ministry has been pushing for a raise of $6 billion per year,
which it claims would bring the Russian regime into line with that of
Kazakhstan, Norway, Canada and other oil-producing countries.10
Starting 1 January 2004 certain changes were made, including increase
in mineral extraction tax rate, increase in excise taxes rates and the
elimination of tax concessions, which allowed Yukos, Sibneft and others
to save an estimated $11.5 billion per year. TNK/BP and LUKoil, no
doubt with one eye on the Yukos affair, have agreed to co-operate,
LUKoil even going so far as to cease voluntarily taking advantage of
existing tax concessions.11 During 2004 the Government continued to
increase the tax burden on oil companies by raising export duties on oil
and oil products (the rate of oil export duty increased from $41.6 to
$69.9 per ton from 1 August 2004). Starting from January 2005, the
rates for all specific oil taxes (mineral extraction tax, excise duties) will
be further increased. Considering the continuing high price level it may
be concluded that with the global oil prices staying at the level of
$33$37 per barrel, around 4045 per cent of export revenues received
by Russian oil companies will be collected through these specific taxes.
Over the past couple of years it has become clear that Production
Sharing Agreements (PSAs), though permitted in law, will only be
made available under a very narrow range of circumstances. The
creation of a legal framework for PSAs was long sought by foreign oil
companies who found the predictable fiscal conditions available under
a PSA regime very attractive. Domestic oil companies were less happy
with what they saw as unfair concessions to foreigners. The result of
this is the restriction of availability of new PSAs to the most complex
and difficult projects. ExxonMobil struggled for 10 years to obtain a
PSA for the Sakhalin 3 block, only to be disappointed in early 2004,
when the government decided not to issue a production licence without
an auction.
Three pre-existing PSAs remain in operation, including the
ExxonMobil-operated Sakhalin 1 and Shell-operated Sakhalin 2
projects. Taken together, these constitute the majority of foreign
investment in Russia, and are two of the largest and most complex oil
and gas projects in the world today. The proximity of Sakhalin to Far
Eastern markets, particularly Japan, Korea and China, gives them a
definite advantage over Siberia as an investment location.
Importantly, the fields covered by these two projects include very large
amounts of gas, and both consortia are investigating export options,
10
11
See Ministry Wants $6bn Tax Hike, Moscow Times, 4 February 2004
See Kremlin Mulling Ways to Raise Oil Tax Ratio, Moscow Times, 22 January 2004.
114
Market Potential
with Sakhalin 1 considering a pipeline to Japan, whilst Sakhalin 2 has

commenced construction of an LNG plant on the island.
The future of the gas industry in Russia remains closely linked to
the gas behemoth, Gazprom. This company controls approximately 94
per cent of Russias gas production and 25 per cent of the worlds gas
reserves; it also controls the domestic gas distribution system and
export pipelines. Although Gazprom has significant private shareholders, it remains closely linked to the State. Over recent years there
has been considerable speculation that Gazprom will be broken up and
the gas market liberalized. Recently the government has drawn back
from this option. The management team at Gazprom is clearly
committed to defending its position, and the political aspects of gas
market liberalization (particularly the impact on domestic gas prices)
are no doubt on the governments mind.
Russia remains an exciting opportunity for oil and gas investment.
The key question is how much excitement investors are prepared to
tolerate. It is clear that the government wishes to retain a significant
level of control over the sector and this has created friction with
investors. Tax concessions are under attack, ExxonMobil has apparently lost Sakhalin 3, Yukos is in the firing line and Gazproms position
is being reinforced, despite talk in the past about reform of the gas
sector. Export routes are under pressure and discussion of private
investment in expansion of the pipeline network seems to be stalled.
On the positive side however, BP has made a major commitment to the
sector, which could not have happened without government support.
Oil prices remain buoyant and the long-term shift to gas as fuel for
power stations underlines the prospects for Russia as home of the
largest oil reserves outside the Middle East and the worlds largest gas
reserves.
3.2
The Business Climate in

the Russian Oil and Gas
Sector
Keith Rowden, Leader, Energy Industry
Services and Igor Lotakov, CFA, Senior
Manager, PricewaterhouseCoopers
Its official! Russia is an energy superpower.

During the Soviet era, Russia and the other republics were among
the largest energy producers in the world. However, because the Soviet
energy sector was off-limits to outsiders and due to Cold War
animosities, the countrys accomplishments in the energy sphere were
not duly recognized on the world stage.
After the collapse of the Soviet Union, Russias production of oil, and
to a lesser extent of gas, fell so sharply that Russian energy exports, of
oil at least, ceased to be a factor in world markets. While leading
Western energy companies recognized Russias tremendous reserves of
natural resources, it was generally believed that a thicket of political,
bureaucratic and infrastructure hurdles combined to make the development of Russias oil and gas resources uneconomic. In fact, views of
Russias potential were so negative that during the early to mid-1990s
almost all global growth in energy production and demand simply
bypassed Russia as if the country didnt even exist on the energy
map.
But, as is almost always the case in the energy industry, the forecasters turned out to be wrong. The Russian energy industry has transformed itself into one of the most important sources of oil and gas in the
world. Asia, Europe and North America are now all knocking on
Russias door seeking partnership and energy security through
Russian oil and gas resources. Many Western companies are operating
in Russia, or are seriously considering investing in Russia so as to get a
jump on the competition.
116
Market Potential
What has driven Russias energy renaissance and what is needed to

keep it going?
While most Western energy majors (with a few notable exceptions)
were ignoring Russia in the early to mid-1990s, a number of homegrown Russian entrepreneurs saw an opportunity and jumped to take
advantage of it. The resulting privatization of much of Russias oil
industry, while controversial, effectively laid the foundations for most
of Russias future oil majors. Several of these companies quickly
enlisted Western service firms to help them manoeuvre the technological learning curve, and, as a result, Russias oil production began to
grow at an impressive rate.
Led by companies such as Yukos, Sibneft and TNK (now TNK-BP),
Russian oil production grew from 6.17 million barrels per day (bpd) in
1998 to 8.54 million bpd in 2003, representing an average annual
growth rate of 6.7 per cent (and 10.9 per cent growth at the 2002
production level of 7.70 million bpd!).
At the same time, oil exports grew by an average annual rate of 10.5
per cent to reach 4.56 million bpd in 2003 from 2.51 million bpd in
1998, and jumped by 20.6 per cent with the 2002 export volume of 3.78
million bpd.
According to data from the RF Ministry of Energy, the first six
months 2004 saw a 10.3 per cent year-on-year increase in crude
production (223 million tons), which supports the generally anticipated
production growth rate of 8 per cent to 9 per cent for 2004 as a whole.
Thus, as far as the world oil market is concerned, Russia with its
current production of 8.96 million bpd has clearly become a key global
player and a leading competitor for the OPEC countries (see Figure 3.2.1).
In contrast to Russias petroleum sector, the gas industry has not
undergone any large-scale privatization. State-controlled Gazprom
enjoys a monopoly in gas transportation and exports and holds licences
to the lions share of Russias gas reserves. Nonetheless, Gazprom and
Russia play a central role in the current energy picture within Europe
and promise to be key players in meeting the growing demand for
natural gas in Asian countries, primarily China, where annual
consumption is expected to reach 70 billion cubic meters (bcm) by the
end of this decade and whose own production will then cover only about
80 per cent of increased consumption levels.
In terms of reserves and production, Gazprom is the largest hydrocarbons company in the world with 28.8 trillion cubic meters (tcm) of
proven and probable reserves. Gazprom also supplies Europe with
nearly 30 per cent of its natural gas needs.
Even as the more dynamic oil industry increased its production at
such incredible rates, Gazprom has not been sitting idle. The gas giant
increased non-FSU exports from 96.5 bcm in 1990 to 133 bcm in 2003,
representing an average annual growth rate of 2.3 per cent.
117
10,000
8,000
6,000
4,000
2,000
Nigeria
Kuwait
United Kingdom
United Arab Emirates
Canada
Venezuela
Norway
China
Mexico
Iran
USA
Russian Federation
Saudi Arabia
Russia IH 2004
Source: BP Statistical Overview of World Energy, the RF State Statistics Service
Figure 3.2.1 Top global crude producers (2003), million bpd
Russian energy supply side: what to expect

However, the biggest question currently on the minds of investors and
analysts is: can the impressive growth of Russias oil industry be
sustained?
There is a consensus among energy industry experts that, from the
standpoint of adequate hydrocarbon reserves and technical capabilities, the answer is a resounding yes. But huge capital investment will
be needed. The Russian government itself projects that the countrys
energy industry will require approximately $240 billion worth of investments by the year 2020. Meanwhile, estimates of overall investment in
the global energy industry over this period reach as high as $16 trillion.
Naturally, given such levels of capital investment, companies will go to
those areas of the world where they believe they can earn the highest
return on investment.
For Russian companies to compete for capital and for Western
companies to invest at the levels needed to continue the remarkable
growth of Russian hydrocarbon production, several factors must be
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Market Potential
considered to encourage continued domestic and foreign investment in

the sector. Likewise, new investors in the Russian market would be
well advised to have a complete understanding of the potential impact
of these issues on their current business plans. Several of these key
issues are outlined below.
Transport infrastructure
The impressive recent growth rates of crude production, which it is
believed will level off at a long-term sustainable rate of 4 per cent after
2008, should help Russia to cross the pivotal 10 million bpd production
threshold within two-to-three years and go well beyond that by the end
of the decade.
One of the largest looming threats to continued production growth is
represented by potential export restraints caused by capacity bottlenecks in the export infrastructure. The infrastructure of Russian crude
exports is based primarily on oil pipeline monopoly Transnefts highcapacity crude pipeline system, which accounts for 79 per cent of current
Russian crude exports. Transnefts system is the worlds largest,
spanning 11 time zones with 48,900 km of pipeline and two world-class
ports at Novorossiysk on the Black Sea and Primorsk on the Baltic Sea.
While Transneft boosted its export capacity from 3.28 million bpd in
2002 up to 3.48 million bpd in 2003 and expects to achieve another 4
per cent increase in 2004, the output of Russias oil companies has
grown at a faster rate, thus forcing the industry to rely on Russias railroads as an alternative. The Russian railway system (RZD), which now
accounts for 17 per cent of current oil export capacity, is also becoming
prone to bottlenecks and, in any case, while economically viable at the
current level of oil prices, does not offer a cost effective long-term alternative to pipeline transport.
The solution to todays clogged oil transport system would come in
two parts and would allow Russia to maintain sustainable production
of over 10 million bpd. The first part would entail building a pipeline to
the northern ice-free port of Murmansk as well as increasing pipeline
capacity to Baltic Sea export terminals, which would minimize reliance
on problematic shipping routes that go through Turkeys crowded
Bosporus Straits. The second component envisages the construction of
a pipeline to China or, alternatively, to the port of Nakhodka on
Russias Far Eastern coast.
The Murmansk pipeline would be 2,5003,600 km long and cost an
estimated $3.4 billion to $4.5 billion to build. One of the major advantages of the Murmansk route is that it would allow for oil shipments to
ports on the East Coast of the United States, a journey of only 9,300 km
as compared to 20,600 km on average from the Persian Gulf.
While both of these proposed alternative routes have been vigorously championed by the private sector, for their part the Russian
119
government and Transneft have insisted on maintaining state control

over crude oil transportation and export quantities and, thus, want any
and all future pipeline projects to be carried out and owned by
Transneft. This includes determining when, and how, capacity will be
increased.
However, there is more to the current infrastructure constraints
than merely limiting export growth. The limited pipeline export
capacity has resulted in a system of quota allocations for each oil
producing company based on its share of total production. In turn, this
creates an artificial stimulus to increase production in order to gain a
larger share of export quotas and encourages companies to continue to
own and operate marginal wells because they need the production to
maintain quotas.
Simply put, the government must put politics aside and move
quickly to adopt and implement solutions to the looming capacity
crisis.
There are obviously many other factors that will affect growth
prospects, including the sustainability of high oil prices to finance
necessary construction, or the necessity for sufficient future growth in
global oil demand that can accommodate Russian production growth
and keep OPEC from attempting to prevent Russia from enjoying its
fair share of the world energy market.
On the gas side of the equation, Gazprom controls access to transportation and, thus, opportunities for oil companies and emerging
independent gas companies to tap into the Unified Gas Transmission
System (UGS) are restricted. In addition to the gas monopolys vast
reserves, Russian oil companies also have gas reserves estimated at
19.2 tcm, the development of which is currently stalled in part because
of low domestic gas prices and the aforementioned lack of access to the
UGS. Russias goal is to significantly increase its gas exports to Europe
(and possibly to the United States). In order to achieve this objective,
the domestic market will need such currently untapped gas reserves as
well as significant investment by oil companies and emerging independent gas companies. In turn, these companies must be given access
to the UGS as well as opportunities to construct their own pipelines.
Tax regime
A fair and predictable tax regime is a fundamental requirement for a
healthy investment climate. Russia has made great strides in lowering
the tax burden on business in general and the energy industry in
particular. But, this situation is likely to change. It has been widely
reported recently that the Russian government believes that energy
companies do not pay their fair share of taxes relative to their net income.
A key element of the current tax regime is that the unified
production tax is effectively a regressive tax, as it is based on export
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Market Potential
prices. Since domestic oil prices are typically lower than export prices
and, in part due to the infrastructure issues noted above, do not always
move in tandem with world prices, the tax burden is greater on
domestic oil. This makes it difficult for non-integrated producers to
make an adequate return and is stifling the development of independent oil companies.
If the government decides to tinker with the tax regime in order to
increase taxes on the industry, it should also move to eliminate the
disproportionate burden of the unified production tax on nonintegrated small producers so as to stimulate the development and
growth of small oil companies.
Whatever shape the tax regime eventually takes, it should be fair
and predictable so that investors can make long-term decisions and
have confidence that tax disputes will be resolved in an impartial
manner. Obviously, a sound legal system is an inherent component of a
fair and predictable tax system. While it certainly appears that businesses will be paying more tax, they must be able to remain confident
that tax disputes, or any legal dispute, can be resolved in a fair and
transparent manner.
Licensing regime
As is the case in most countries, the Russian Federation retains
ownership of all mineral resources. Oil and gas companies gain rights
to exploit hydrocarbon reserves by being awarded licences by the State
through a competitive tender process or by acquiring an interest in a
company that already holds a licence.
Russias current licensing regime has been in place since the fall of
the Soviet Union and has remained fairly stable. However, licences can
feature numerous administrative and detailed minor technical
requirements that make ongoing compliance with licence terms
difficult. The RF Ministry of Natural Resources, which is responsible
for administering licences, has consistently demonstrated a willingness to work with licence-holders in amending licences so that
companies can continue to hold a licence. But, this process is overly
bureaucratic and costly and also exposes companies to the vagaries of
politics or bureaucratic meddling.
Likewise, transferring a licence is a difficult process and can take
from 18 months up to two years to accomplish, if at all. As a result, it is
difficult for large companies to dispose of non-core properties and for
new companies to enter the market or grow through acquisition.
Finally, although licence terms require preparation of and
adherence to a development plan that covers the life of the given field,
essentially all existing licences are for terms of no more than 25 years.
Since most Russian oil and gas fields have reserve lives substantially
greater than 25 years, energy companies face the risk, albeit small,
121
that licences may not be renewed. As the end of a licence term

approaches, this uncertainty could impact investment decisions or
impair proper field exploitation.
Streamlining the licence regime by making tenders more transparent, reducing the bureaucracy involved in maintaining a licence,
making licence transfers easier and extending all licences to the life of
the given field would help to reduce costs for large companies and
attract smaller entrepreneurial companies into the industry. In
markets like the United States, Canada and the North Sea, historical
experience has shown that smaller companies were able efficiently to
grow production and reserves in areas where large companies could
not. Thus, a growing number of small companies in the industry could
spell significant production growth for Russia.
Environmental regulation
Currently, Russia has few environmental restrictions, thus making it
easier to do business here than in many developed countries. But,
Russia has never had comprehensive environmental laws or regulations with the result that oilfields, pipelines and other infrastructure
facilities may require costly and substantial environmental clean-up
efforts in the future. Existing Russian companies and companies
considering investment in the energy sector face the risk that new
regulations will come into play requiring large-scale clean-ups, thus
saddling current licence-holders or property owners with massive
environmental liabilities.
Russia must balance its environmental regulation needs with the
abilities of the industry to fund clean-ups and ongoing regulation.
Whatever the solution, energy businesses need a clear and fair regulatory framework in order to make proper investment and capital allocation decisions.
Corporate governance
A lack of effective regulation together with a willingness by owners to
exploit weaknesses in corporate and securities laws represented a
significant barrier to foreign investment in the past. However,
improved laws, and increased awareness that good corporate governance can tangibly add value to businesses, have resulted in a marked
improvement in corporate governance practices in Russia. However,
more needs to be done to insure the free flow of capital necessary to
maintain the pace of oil and gas resource development.
At a minimum, securities regulation should require that public
companies report at least bi-annually on a group basis and that those
companies have a truly independent board of directors. The planned
requirement that these companies report under International
Financial Reporting Standards (IFRS) should also be accelerated.
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Market Potential
Besides the obvious benefits of such regulation, the mandatory

adoption of IFRS would likely lead to accelerated development of
management systems and reporting processes, resulting in more efficient management, lower costs and increased transparency for stakeholders. This would in turn lead to more investment in the energy
sector.
Russia has come a long way and its accomplishments to date should
not be diminished. ExxonMobil and its partners have committed an
estimated $12 billion to the Sakhalin I project. Royal Dutch Shell and
its partners also expect to invest close to $12 billion in Sakhalin II. BP
has invested nearly $7 billion in the TNK-BP joint venture. Likewise,
Russias five largest oil majors have been investing around $6 billion in
their up-stream operations every year, largely from their own cash
flows, and are planning to increase this figure up to $8 billion by 2005.
So, clearly these companies believe that the risk reward model is
favourable.
But, in order to tap the vast resources yet to be developed and to
improve Russias status as an energy superpower, more capital will
likely be needed. Direct investors into Russia and those investing in
Russian companies would be wise to gain a full understanding of the
issues discussed above and to work constructively with Russian regulators to improve conditions for businesses and all of their stakeholders.
3.3
The Oil and Gas

Industry: The
Regulatory
Environment and Legal
Infrastructure
CMS Cameron McKenna
Introduction
Russias extensive oil and gas reserves have attracted energy
companies from all over the world. This chapter describes the most
important Russian oil and gas legislation and summarizes a number of
its most important provisions.
Russias oil and gas sector is overseen by the Ministry of Energy of
the Russian Federation. Russias oil sector is dominated by large jointstock companies created by privatization. Russia initiated a two-step
oil privatization process in 1993. The first phase, which involved organizing state-owned enterprises as joint-stock companies, ended in 1994
and resulted in the establishment of several vertically integrated oil
companies. The second phase, which has been ongoing since 1995,
involves the auctioning off of government shares in these companies.
Legislation
Russian oil and gas legislation is based on the Constitution of the
Russian Federation and the following three laws constitute the basic
legal framework for oil and gas exploration and production:
Law On Underground Resources of 21 February 1992 (Sub-soil
Law);
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Market Potential
Law On Production Sharing Agreements of 30 December 1995 (PSA

Law);
Law On Gas Supply in the Russian Federation of 31 March 1999.
Russian legislation provides two distinct regimes for oil and gas exploration and production. First, the Sub-soil Law establishes a general
licensing and administrative law regime under which federal and local
authorities issue, amend and terminate rights granted by licence.
Second, the PSA Law establishes a quasi-contractual regime for
production sharing agreements (PSAs) between the investor and
federal and local government.
The Sub-Soil law

The general principles of the oil and gas legislation are set out in the
Sub-soil Law, which establishes the administrative system for the
exploration and production of mineral resources and defines the State
as the owner of all mineral resources in the earth. The Sub-soil Law
also defines the scope of authority of the federal and local governments
in the mineral resources sphere. Every subject of the Russian
Federation may adopt its own legislation on the use of natural
resources within the scope of authority granted to it by the federal
legislation and by any agreement defining the scope of authority that
may have been entered into by the Federal Government and the
government of the subject. There are 89 subjects of the Russian
Federation including the republics, oblasts and federal cities.
The Sub-soil Law states as a general principle that a licence to use
sub-soil resources may be issued to Russian or foreign legal entities. A
licence to produce oil will be issued in most cases only after a tender
and on the basis of a joint decision of the federal and local authorities.
The Ministry of Natural Resources of the Russian Federation and its
territorial agencies issue the licences to use sub-soil resources. The
issuance of the licence may also be subject to approval by federal
mining safety and environmental agencies.
A licence confirms the right of the licence-holder to use sub-soil
resources according to the terms and conditions defined in the licence.
The terms and conditions stipulated in the licence remain in effect for
the period stipulated or for the whole term of validity of the licence. The
terms and conditions may be changed only with the consent of the
licensee and the authorities which granted the licence, or in certain
other cases defined by law.
The basic criteria applied by the relevant authorities when deciding
a tender are the scientific and technical level of the proposed
programmes for geological study and use of sub-soil, the extent of
The Oil and Gas Industry: Regulatory and Legal
125
mineral extraction proposed, the contribution to the social and

economic development of the territory, and the effectiveness of the
environmental protection measures proposed and national security
interests of the Russian Federation. Usually however, the winner of an
auction for a sub-soil licence is determined on the basis of the total
amount offered to be paid for the right to use that sub-soil block.
All information on forthcoming tenders for sub-soil user rights is
published in the Russian national media and local media for the
different subjects of the Russian Federation.
The PSA Law

The PSA Law establishes a special regime for production sharing
agreements. Russia has had a law on PSAs in place since 1996 but, due
to delays in adopting additional legislation, few projects have gone
forward on production sharing terms. PSAs according to Russian legislation should be treated as civil law contracts subject to a special
statutory regime and entered into between the Russian Federation and
an investor or investors.
In general, a PSA is implemented as a result of an open tender
conducted by the Russian Federation. The winner of the tender negotiates the terms and conditions of the PSA with the federal government
and the relevant local government. The PSA defines the rights and
obligations of the investor and the Russian government for example,
the PSA will set out a formula for calculating how the winner of the
tender and the Russian government will share the hydrocarbons
produced. Production is split into cost production and profit
production (though such distribution may be changed in accordance
with a PSA). The cost production belongs to the investor to pay off the
costs of the project, while profit production is divided between the
investor and the Russian government.
The PSA Law does not eliminate the requirement to obtain a licence
for the use of mineral resources under the Sub-soil Law, but the
government is obliged to issue the licence within 30 days from the date
the PSA is signed. The PSA Law prohibits the government from
revoking the licence once the PSA is concluded. For a field to be
developed on a PSA basis, it must first be approved by a Federal Law,
often referred to as a List Law.
Tax
The tax burden is one of the most significant issues for those oil and
gas producers in Russia that operate under the Sub-soil Law regime.
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Market Potential
Among the numerous taxes that producers are required to pay are
excise tax, property tax, tax on production of mineral resources, transportation tax, unified social tax, profit tax, and value added tax. In
addition, the Sub-soil Law requires producers to make regular
payments for the use of sub-soil as well as one-off payments upon the
occurrence of certain events stipulated by the licence, and payments
for geological information on sub-soil. A fee is also charged for participation in a tender (auction) and for the issuance of licences.
Producers involved in projects developed on production sharing
terms under the PSA Law are also required to pay the following taxes:
excise tax, mineral production tax, tax for use of mineral resources,
transportation tax, land and environmental taxes, unified social tax,
profit tax, value added tax.
The PSA Law provides that parties to the PSA may elect international arbitration for dispute resolution. For the purpose of a PSA the
Russian Federation may waive its sovereign immunity.
The PSA Law still contains some disincentives to foreign
investment. Each PSA is required to have at least 70 per cent of
equipment, materials and technical assets used in the PSA project
(measured by cost) produced by Russian companies or by foreign
companies carrying on business and registered for tax in Russia. At
least 80 per cent of employees must be Russian citizens with foreign
employees restricted to the first stages of the project or when no appropriately qualified Russians are available.
The Sakhalin I and Sakhalin II projects, each being developed by
consortia that include Western companies, currently operate under
PSAs. Those PSAs, however, were signed in 1995 before the PSA Law
came into effect. The Sakhalin II project produced its first oil in July
1999.
Gas
Russias gas sector is dominated by the joint-stock company Gazprom
(RAO Gazprom), which is 38 per cent owned by the government of the
Russian Federation. RAO Gazprom was established by the decision of
the government of the Russian Federation of 17 February 1993. It has
a dominant position in the gas production and distribution market
owning almost all gas production, transportation and distribution
facilities in the territory of the Russian Federation.
Transport issues
The company Transneft has a monopoly over crude oil transportation,
while the company Transnefteprodukt transports petroleum products.
The Oil and Gas Industry: Regulatory and Legal
127
Tariffs are generally established by the State. Oil companies and joint
ventures are constrained in their ability to export crude oil by two
factors:
there is only limited capacity in Russias oil pipeline system for
transporting oil to points outside Russia;
the Russian government limits exports to ensure domestic supplies.
For a variety of reasons, the price of crude oil is significantly lower in
Russia than abroad, which makes it unprofitable to sell oil domestically.
3.4
Investing in a
Reforming Electric
Utilities Industry
Alexander Chmel, Partner and Vyacheslav
Solomin, Senior Manager,
This chapter provides a short overview of the Russian utilities

industry and a more detailed analysis of current and anticipated
future developments with regard to Unified Energy Systems of Russia
(RAO UES Rossii), the all-Russia electric utilities holding company, a
Company whose operations are spread over 12 time zones and which
employs about 600,000 employees.
Background on the Russian electricity industry

The electricity sector is one of the last branches of the Russian
economy that has yet to change significantly the administrative
methods it inherited from the Soviet era. In addition, virtually all of
the major present-day power stations and electricity grids were
inherited from the Soviet period. It is clear that this historic system
has limited flexibility and significant structural problems. Today
everyone in Russia who consumes electricity and heat, effectively
benefits from the investments made under the Soviet Union, but
change is essential as this is no longer a tenable situation.
The current structure of the electricity sector includes:
RAO UES Group, a 53 per cent state-controlled holding company,
which controls and operates the power system in Russia. The
company controls 73 vertically integrated regional energy utilities
(known as Energos); 23 stand-alone thermal power plants (TPPs); 8
hydro-generation plants (HGPs); and a huge network of high-
129
voltage transmission grids. The RAO UES Groups generation facilities boast a total installed capacity of over 155 GW, which represents approximately three-quarters of the countrys total installed
capacity. The RAO UES Group also controls over 96 per cent (in
length) of the electrical grids in the country;
Rosenergoatom, a state-owned holding company controlling all 10 of
Russias nuclear power plants (NPPs), which have a combined
installed capacity of approximately 22 GW;
independent producers (Irkutskenergo, Tatenergo, Bashkirenergo,
Novosibirskenergo), which have a combined installed capacity
exceeding 27 GW;
other producers, including generation facilities owned by enterprises in other industries (eg oil and gas producers).
As illustrated above, RAO UES Group is effectively a monopoly in the
area of energy supply, which additionally operates and co-ordinates the
power system in Russia. Consequently, the future strategy for the reform
of RAO UES is a hugely important issue for the development of the
national economy.
The main areas of the RAO UES Groups business activities are:
electricity and heat production, transmission and distribution;
management of the Unified Energy System of Russia (UES of
Russia), organization of UES of Russia operations, provision of
services for the Federal Wholesale Market of Electricity and
Capacity (FOREM);
operational dispatch management of the technological process of
power generation and supply;
technical monitoring of the condition of UES of Russia power plants
and power grid facilities;
construction and commissioning of power industry projects, as well
as analysis and forecasting of changes in power supply and demand.
RAO UES Group controls, via its wholly-owned subsidiary, CDRFOREM, the FOREM, where all the participants sell and buy centrally
prescribed volumes of energy based on government-regulated tariffs.
Through another wholly-owned subsidiary (CDU-System Operator),
the RAO UES Group exercises operational dispatch management of
the technological process of power generation and supply by all
FOREM participants.
RAO UES Group also owns, through its 100 per cent subsidiary
Federal Grid Company (FGC), a system of high-voltage transmission
grids, which extends to almost all parts of Russia and connects all
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Market Potential
regions of the country, with the exception of certain remote areas in

Siberia and Russias far east.
Energos, regional utility companies, with exception of a few, are
subsidiaries of RAO UES Group. Energos are currently verticallyintegrated companies that produce, distribute and sell electricity and
heat to industrial and residential customers using cost-based tariffs
approved by local governments. Energos can sell any excess energy
they produce through FOREM to either other Energos or other participants or, similarly, replenish any deficit of energy by acquiring energy
from TPPs, NPPs and HGPs. Although controlled by RAO UES, most
Energos have significant minority shareholders.
Change imminent
It is commonly recognized that the current structure of the Russian electricity sector does not meet the needs of any of its principal participants:
Energos complain that regional authorities and their energy commissions are setting artificially low tariffs for retail customers, for populist
reasons, at the expense of industrial consumers (so called crosssubsidies) and that current tariffs are insufficient to allow Energos to
maintain the system in a working state or deliver a return on equity.
Regional authorities blame Energos for overstating costs in coming
to their cost-plus tariffs (and resisting any reduction in their costs)
and for discontinuing energy supply to slow-paying customers, especially ones that are financed by the government.
Industrial and retail consumers complain that they have to pay high
prices for energy, but a safe and stable supply is still not guaranteed.
Electricity pricing is clearly affected by political and human factors in
Russia. As mentioned above, cross-subsidizing, where the industrial
consumers have to, in effect, subsidize power tariffs for residential
customers by overpaying for their own electricity, is still a widespread
feature of the industry. Such practices, together with inefficient energy
consumption by most industries, sometimes makes certain products
uncompetitive. Under the existing structures, Energos often lack any
motivation to reduce costs and consumers, particularly residential
consumers, lack any motivation to conserve energy.
Macroeconomic factors are also involved. Amongst Russias key shortterm objectives is the development of a stable market economy and
sustainable economic growth. Given the key role played by the electricity
sector in any successful economy, the need to make effective progress in
liberalizing the sector in Russia is a major issue. The country inherited
a huge invested infrastructure from the Soviet era, but that infrastructure is aging and demand shows strong signs of growth.
131
In order to solve or mitigate potential regional or national supply

problems, the electricity sector needs significant capital investment.
Volumes of this investment are such that they are unlikely to be
financed by the State. Some private capital is available in Russia and
there are also financial institutions and companies in the world that
specialize in large investments in the electricity sector. However, for
many national and international investors the Russian electricity
sector continues to be perceived as being too risky for significant direct
investments, not least because of uncertainly over future market structures and because individual Energos often do not meet the minimum
investors requirements of financial and operational transparency.
Reform: Objectives and principles

The problems highlighted above demonstrate the need for structural
reforms in the Russian electricity sector. In response to these problems,
the State has adopted legislation to conduct reforms in a series of steps.
Most fundamentally it is envisaged that monopolistic (energy
dispatching and transportation) and competitive (generation and selling)
businesses will first be separated and then market conditions introduced
to the competitive part of the electricity sector (see Figure 3.4.1).
Reform Basics: Separation of Monopoly and Competitive Sectors
Competitive
sectors
Generation
Sales
Free price-setting
Stimulating
market entry
Market
rules
Natural
monopolies
Transmission
Distribution
Dispatching
Securing equal
access to grids
Setting up market
infrastructure
Regulated
tariffs
Figure 3.4.1 Reform basics

As was mentioned above, all major stakeholders in the electricity
sector, including the government, acknowledge that some structural
changes are needed in the sector if it is to meet the challenges created
by its history and the current economic environment.
The major objectives and steps of the reform programme include:
Optimizing the industrys structure by:
creating a transparent and competitive market place;

improving overall economic efficiency of the system;
ensuring financial viability of individual market participants;
securing affordable end consumer electricity prices.
132
Market Potential
Creating an attractive investment profile by:

encouraging capital investment into areas where new build is
required;
raising economic competition and quality through involvement of
foreign strategic investors;
establishing a clear and effective regulatory framework;
enhancing shareholder value;
ensuring fair treatment of minority shareholders.
Address social consequences of reform by:
ensuring smooth transition to a deregulated market with
minimal price shocks;
ensuring reliability of the new system.
Reform will, or is already, affecting all the segments of the RAO UES
Group and other elements of the Russian electricity sector. The key
features are:
Energos will be divided by line of business (generation, distribution
grids, sales), as shown in Figure 3.4.2. After an initial process of
unbundling, a second process of interregional integration along lines
of business will take place. In effect, the newly separated regional
generating and grid companies will merge to form larger, single
activity companies.
Territorial (interregional) generation companies, formed from the
mergers of spun-off generation companies, will then become electricity market participants.
Ten wholesale generation companies will be formed, based on
thermal and hydro-generation plants.
Inter-system and high-voltage electric grids will be merged into the
Federal Grid Company which, as a natural monopoly, will then be
acquired by the state.
Dispatching of energy will be conducted by another state-owned
entity, the System Operator.
Markets: The RAO UES Group will still manage the regulated
FOREM, while the Administrator of the Trade System (power
exchange) will become the forum for all sales, pricing, negotiating
and contracting of purchase and sale on the non-regulated sector of
the power market; it is envisaged that this market will account for
515 per cent of the total volume of energy traded in Russia for the
period to 2006.
133
Basic model for reforming an Energo
AO-ENERGO
MANAGEMENT COMPANY
GENERATION
GRIDS
GRIDS
SALES
GENERATION
SALES
1 Shareholders of an Energo get the proportional quantity of shares of all

newly created companies
2 Mergers of generation and grid companies on interregional basis
Figure 3.4.2 Regional Energos: Basic model of unbundling

The anticipated timeline of proposed reforms is illustrated in Figure
3.4.3.
Objectives
Market
Structure
Tariffs
2001 - 2004
2004 - 2006
2006 - 2010
First Phase
Second Phase
Third Phase
Development of the
legal framework
Revision of the
market structure
Pilot test of the
wholesale market
Set-up of competitive
electricity market in
generation and supply
Attract private
investments in various
sectors of the industry
Federal Grid Company

Wholesale generation
companies
Unbundled vertically
integrated Energos

and regional distribution
companies
companies
Regional generation
companies
Supply companies

and regional
distribution companies
companies
Regional generation
companies
Supply companies
Transmission tariff
introduced
Distribution tariff
introduced
Unregulated market
(5-15%)
ISO tariff introduced
Government-set tariffs
remain for FGC, grids
and heat only
Generation and supply
are unregulated
Government-set tariffs
remain for FGC, grids
and heat only
Competitive
electricity market
Figure 3.4.3 Anticipated timetable
134
Market Potential
Although it is clear that separation of competitive and monopoly (regulated) activities is vital for further development of market principles in the
electric utilities industry in Russia, there has been considerable debate as
to whether the scenario of spinning off various businesses with proportionate shareholding (as adopted by the Russian Government) is the most
appropriate or equitable one in the current Russian environment.
Stakeholders
This question of the equity of reform is centered on the various shareholder groups currently invested in the electricity sector in Russia. It is
important to remember that there are two levels of shareholders, who
openly (or via nominal holding structures) own shares in:
the parent company, RAO UES Rossii;
underlying Energos/power plants.
The State, is the main stakeholder and shareholder (about 53 per cent
of shares) in the Parent company RAO UES Rossii, and, hence, indirectly, in its subsidiaries.
Other shareholders in either the Parent company and/or the underlying Group entities have changed dramatically over the last 12
years. Those who in principle agreed with the governments base
scenario of reform, were predominantly portfolio investors; in general
these shareholders wished to retain an investment in the electricity
sector. Recently such shareholders have tended to be bought out by a
cohort of strategic investors who have had quite different interests. In
particular, they appear to be less interested in fair, proportionate
spin-offs. Instead, they appear to wish to obtain control (paying a fair
price if needs be) over specific businesses in specific regions.
The first pilot reform project (Tulenergo) was completed in
November 2003 and illustrated how an unhappy strategic investor
with a blocking stake could, in practice, stop the reform process. This
example and the underlying range of motives for shareholders mean
that the forthcoming 2004 reforms will be most intriguing. More than
20 major Energos are expected to hold their extraordinary shareholders meetings during April to October of 2004 to make decisions as
to whether they accept the current reform scenario or not. In this
context, and with regular changes in government personnel, the future
shape and speed of reform remains uncertain.
Investment opportunities in a new industry

One of the justifications of reform being pushed from the top is the
perceived need for new investments amounting to many billions of
135
dollars in the industry. New investment opportunities mirror key

features of the proposed reforms:
Separation of competitive and regulated businesses (accompanied
by establishment of a separate transmission tariff and real market
price for electricity) should result in a higher level of transparency of
the industry, which in turn should make it more attractive to
investors.
The new competitive electricity market (appropriately supported by
market reforms in natural gas supply and municipal consumption)
could make generation businesses attractive for IPP-type investments, which appear vital in light of current very low efficiency and
high obsolescence of generation assets in use.
As the restructuring process is going on, the number of independent
entities operating in the industry will increase many times, creating
a solid mass of entities ripe for corporate acquisitions, mergers etc.
Significant corporate reform is expected to happen in the postreform period under pressure from strategic investors, whose
interests may not be met during the main reform process.
The combination of the above factors should ensure that the electricity
sectors role in the stock market becomes more interesting for those
who prefer to remain portfolio investors.
Conclusion
As the brief discussion above highlights, the electricity industry is
facing major change over the coming few years. The proposals
regarding the structure of reform, and indeed experience around the
world of similar reform programmes, suggest that reform will bring
both significant challenges and opportunities for all participants in the
electricity sector in Russia. Given the scale of the industry and its key
role in the Russian economy, the prospects look electrifying.
3.5
Russian Energy Sector

Policy
Sergey Maslichenko, OTAC Limited
Introduction
Russian Energy Sector Policy envisaged in the Energy Strategy to
2020 (the Strategy) and adopted by the Government on 28 August 2003
has become a hot topic in professional discussions among Western and
local economists. The scope of these debates range from the appraisal
of the future level of energy savings required to meet optimistic GDP
growth forecasts up to revealing the role of lobbies in gas, oil and coal
production estimates with a view to obtaining additional financial
preferences from the State. In short, a variety of interrelated political,
economical, legal and social issues at the micro and macro levels are
involved in the analysis of the energy strategy.
This chapter examines the dominant constraints in Russian energy
strategy to 2020, and the process of elaborating a feasible energy policy
in Russia. It focuses on the policy-oriented investigation of energy
balance forecasts, based on the Ministry of Energys decisions, on
expert judgements, and mass media publications in regard to supply
and demand for gas, oil, coal, and electricity. This includes an
assessment of energy consumption based on estimation of GDP growth
and level of energy efficiency that will be achieved to meet energy
constraints, and an analysis of the feasibility of market reforms and
investment in the sector.
GDP growth
The most important element that determines the general energy
strategy and particularly the energy balance forecast is the estimation
of the GDP growth rate. As all energy consumption in Russia will
depend on the countrys economic growth, accurate estimations of
137
1) growth rates of GDP; and 2) the structure of GDP have to be undertaken in order to plan the energy sector development.
According to the optimistic scenario of the Strategy, Russian GDP
will increase from 2000 to 2020 by 3.3 times (2.3 under the moderate
scenario). This means that the economy is projected to grow by an
annual average of 5.2 per cent during 20002005 and 6.6 per cent
during 20062020 under the optimistic scenario and by about 4.4 per
cent per annum under the moderate scenario.
Russia has indeed experience several years of relatively strong GDP
growth: 10 per cent in 2000, 5 per cent in 2001, 4.3 per cent in 2002 and
7.3 per cent in 2003, but the Russian economy has remained very
dependent on hydrocarbon exports.
In this regard, many analysts suggest that Russias recent strong
economic performance was due to an equally impressive increase in the
price of hydrocarbons. Employing the results of a World Bank study,
the most plausible estimate implies that 3 per cent of the 7.2 per cent
growth in the first half of 2003 was due to the direct and indirect effects
of the oil price increase and 4.2 per cent to non-oil factors. In other
words, had oil price stayed constant, the growth of Russias economy in
the first half of 2003 would have been only 4.2 per cent.
In addition, the study reveals some interesting facts: since the 1998
crisis, Russias economy has only grown faster than 5 per cent when the
oil price has increased at the same time. This means that, given the
way in which Russias economy is currently organized, growth rates of
above 5 per cent will require either an additional increase in the oil
price, which in the long term is unlikely, or growth of the economys
productivity, which means that more reforms and more structural
changes are needed.
Apart from the estimate of GDP growth to 2020, the structure of
industry output needs to be considered in order to forecast the energy
demand and supply. A key question that defines future energy
consumption is the extent to which economic growth will be independent from hydrocarbons. The only estimate that the Strategy
provides is the forecast of the energy sector share of industry output to
2020. It is estimated at 18.7 per cent under the favourable scenario and
19.2 per cent under the optimistic scenario, which is significantly less
than the 29.5 per cent of energy sector production in the total industry
output in 2000.
Energy efficiency constraints

The Strategy provides some estimations of the size of energy savings to
be achieved by 2020. Overall energy efficiency potential in Russia is
estimated at 3947 per cent of current energy consumption, or 360430
138
Market Potential
million tce.1 According to the Strategy, a third of this potential is in the

energy sector itself, 3537 per cent in industry and 2527 per cent in
public services.
From 2000 energy intensity is forecast to decrease by 2627 per cent
to 2010 and 4555 per cent to 2020. Half of GDP growth will be
achieved without energy consumption increases, due to the structural
reforms in the economy, 20 per cent of GDP growth will be generated by
technological energy efficiency measures and the rest 30 per cent of
GDP growth will require an energy consumption increase.
350
GDP and energy consumption growth based on
the energy consumption level in 2000
300
Forecasted energy consumption growth without

structural reforms
Desired energy consumption growth
technological
changes impact
254
250
242
200
195
173
150
152
131
120
100
2000
108
2005
Structural
reforms impact?
140
127
100
334
121
2010
2015
2020
Source: Russian Energy Strategy to 2020
Figure 3.5.1 Forecast GDP and energy consumption growth (%)

Thus, while GDP is supposed to grow 2.33.3 times between 2000 and
2020 the energy consumption of the Russian economy is forecast to
increase only 1.251.4 times. Moreover, over 50 per cent of the energy
efficiency increase will depend on structural reforms, which are not
clarified in the Strategy; neither is there any clear identification of
what economic mechanisms (and their relative impact) should be
1
Tce tonne of coal equivalent the unit of energy consumption measurement based on
the ability of fuel to generate energy, which allows comparison with different types of
fuels (gas, oil, coal, etc).
139
employed to reach the targeted efficiency. The only mechanism that the
Strategy provides is the price increase of gas and electricity, with no
explanation of its impact on energy efficiency.
In this respect, we think that the relatively high level of forecast
energy efficiency that is supposed to be achieved by undertaking significant progress in structural reforms may underestimate energy
consumption in Russia. This may cause additional pressure on the
energy sector, which would require either additional production of
energy or a decrease in energy exports.
Energy balance forecast

In general, the Russian Energy Strategy to 2020 has been written in
such a way that energy consumption forecast (demand for energy) has
been given much less attention than energy production (supply side)
estimates. To some extent, this can be explained by the prevalence of a
central plan approach in elaborating the Strategy, which is still
prevalent in various Russian ministries. Apart from that, some
analysts (eg ISDEI) suggest that the relatively detailed forecast of
energy supply, as opposed to energy demand, resulted from lobby
pressure on the Ministry of Energy. To this extent, some influential
Russian financial-industrial groups (particularly oil companies) were
not happy with the future course of structural reforms, which could
potentially decrease their share of GDP and reduce their current privileges (tax exemptions, investments, etc). In other words, to retain
status quo and perhaps obtain new privileges such business groups
envisage expansion of the energy sector in Russias economy with no
accompanying analysis of how such an increase in production could be
met by energy demand. This argument is also supported by the significant increase of investment requirements that are claimed by energy
companies in order to support forecast growth of the Russian energy
sector (see below).
Energy consumption
Given the lack of detailed estimates of future demand for energy in
Russia, the Strategy provides only a rough approximation based on
the GDP growth forecast and desired level of energy efficiency that
might be achieved. Assuming that todays demand for energy in Russia
is about 915 million tce and energy consumption will increase by
1.251.4 times by 2020, the energy demand is forecast to be
1,1451,270 million tce.
It is supposed that the gas consumption share of energy demand will
drop from 50 per cent to 4546 per cent by 2020. Oil and oil products
140
Market Potential
will have a 2022 per cent share, and coal 2022 per cent. Apart from
these aggregate figures, which seem to represent only desired intentions and are not supported by any economic justification, the Strategy
doesnt provide any evidence on what sectors will consume energy
resources. The general perception is that these figures were inserted in
the Strategy without any preliminary forecast of the energyconsuming sectors development.
Analysis of the dominant energy consumers in Russia based on
Goskomstat Input-Output tables (Sistema tablits Zatraty-Vypusk
Rossii za 2000 god) revealed the following conclusions:
a significant share of primary energy resources (gas, oil, coal) is
consumed within the energy sector itself (82 per cent of oil is utilized
by the refining industry and 14 per cent by the oil industry itself;
31.6 per cent of gas is consumed by the electricity sector and 11.1 per
cent by the gas industry itself, 20.8 per cent of coal demand is used
by the electricity sector and 12.2 per cent by the coal sector);
as a large part of primary energy resources are consumed by the electricity sector, the forecasted development of the whole energy sector
will depend heavily on the progress in the electricity sector and on
demand for electricity from the electricity consuming industries;
as electricity was consumed mostly by service sectors (transport,
communal services, and social sectors), ferrous and non-ferrous
metallurgy, machine building and the chemical industry, the energy
consumption forecast will depend on the economic and technological
reforms in these branches of industry in particular, which determine
the level of their future growth as well as energy efficiency gains;
the energy efficiency and consumption forecast for the Russian
economy will depend, to a great extent, on the administrative and
budget reforms that the Russian government has to undertake in
the near future in order to increase the energy efficiency of public
organizations and communal services companies.
According to the Strategy, higher coal consumption is assumed to
substitute for some share of gas consumption. The main reason,
according to the Strategys authors, is to halt the gas pause when
cheap gas is inefficiently consumed by the Russian economy, and to
employ the large potential of the coal industry instead. This is intended
to be achieved by increasing the gas price, which will result in stabilization of the gas/coal price ratio at the level of 1:1 in 2006, 1.4:1 in
2010, and 1.62:1 in 2020 (in 2002 the ratio was 0.62:1 in tce).
As the increase in coke production is forecast at significantly lower
rates (29 per cent from 62 million tonnes in 2002 to 7580 million
tonnes in 2020) than production of steam coal (83 per cent from 191
141
million tonnes in 2002 to 325350 million tonnes in 2020), the main

consumers who will have to substitute coal for gas are supposed to be
the thermal power stations.
The authors of the Strategy believe that the projected increase in
gas prices will induce the electricity sector to decrease demand for
natural gas in favour of steam coal. Apart from the environmental
consequences of such a policy, there is great concern about the feasibility of such a scenario for the electricity sector.
Most experts and executives of RAO UES (the company that owns
the majority of thermal power stations in Russia) suggest that despite
the desired increase in the gas/coal price ratio (which is itself questionable: RAO UES predicts that the ratio wont exceed 1.29 by 2020 as
the coal price will be increasing faster), there are technological,
economical and environmental factors constraining the electricity
sectors switch from gas to coal:
1. A working group of RAO UES and the Russian Academy of Science
created in 1999 investigated 82 thermal power stations and found
out that only 28 stations have the potential to be converted to the
consumption of coal. To do that, moreover, these stations will require
an additional $3.5 billion investment for restoring the coalconsuming technology (including storage facilities for coal and coal
waste) and providing ecological safeguards. At the same time, they
can economize on gas consumption for about 10 bcm (equivalent to
$400 million, at an assumed gas price of $40 per tcm). Even then,
this scenario implies conservation of outdated, depreciated and inefficient technology.
2. Whereas 80 per cent of thermal power energy is produced in the
European part of Russia, most coal production is located in Siberia.
So there will be a transportation constraint upon increased coal
consumption in the electricity sector. A significant part of the coal
price (49 per cent for Kuznetsk basin coal, and 73 per cent for
Kansko-Achinskiy basin coal) is in transport expenditure. Another
scenario that suggests the production of electricity in Siberia and its
subsequent transportation by power lines to the European part of
Russia is also constrained by the relatively small capacity of these
lines, which require investment of about $2.8 billion. Apart from
that, there is also the problem of the high level of energy waste when
transporting electricity over such long distances.
3. A higher gas price could bring efficiency improvements in gas
consumption rather than the expansion of coal consumption. There
are several options for decreasing gas consumption by installing
new gas and steam equipment. Investment in new gas-steam
engines (with an efficiency saving of 5060 per cent) is estimated at
142
Market Potential
$500 per 1 kW capacity, while technological changes for coal use will
cost $600 per 1 kW and investment in new coal engines (with an efficiency saving of 4546 per cent) is estimated at $1,000 per 1 kW
(RAO UES website).
Energy supply
Coal production
According to the Strategy, the main incentive for a rise in coal
production is the forecast of a gas/coal price ratio increase. It is estimated that coal supply will increase from 258 million tonnes in 2000 to
430 million tonnes in 2020 (optimistic scenario) or 370 million tonnes
(moderate scenario) (see Figure 3.5.2). Given the fact that actual
production of coal decreased to 253 million tonnes in 2002, this means
that between 2003 and 2020 coal extraction will have to grow by an
average 6.59.8 million tonnes per annum which, taking into account
the recent trends in coal production and the presence of a number of
constraints, seems unlikely to be achieved.
While Russia has huge deposits of coal (200 billion tonnes, 12 per cent
of the world total), extraction of additional coal is constrained by
unfavourable geographic, geological, and economic factors (Strategy, p.60).
The dominant constraint is the extensive physical depreciation (7585
per cent on average) of the sectors fixed assets and the outdated level of
395.4
353.3
335.8
305.3
271.3
coal production
moderate scenario
optimistic scenario
430
360
330
262.8
269.5
253.4
258.4
244.4 232.3249.1
310
280
270
255
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
375
345
2005 2010 2015 2020
Source: Ministry of Energy statistics, Russian Energy Strategy to 2020
Figure 3.5.2 Coal production in 19902002 and its forecast to 2020

(million tonnes)
143
technology. Taking into account that the level of state support for the
industry has declined dramatically and that its own cash flow is quite
inadequate (in 2002 balance losses, before taxes, of the coal industry
reached 1,439.3 million roubles (about $48 million), it is unlikely that
sizeable progress in the renovation of the industrys capacity and in the
provision of new efficient technology will occur in the near future.
As a result, with existing low rates of investment in the industry the
production of coal is, at best, likely to grow perhaps to 280290 million
tonnes in 2020 (Russian Coal magazine) compared with the 370430
million tonnes suggested by the Strategy.
According to the Head of the Coal Industry Department of the
Russian Ministry of Energy, the coal industry needs investment of 15
billion roubles ($500 million) per annum just in order to maintain
production of 270 million tonnes per annum never mind increasing it
(Russian Coal magazine). For comparison, in 2000 the overall
investment in the coal industry was 8 billion roubles, the forecast for
2001 was 13.3 billion roubles.
Oil and oil products supply

According to the Strategy, oil production growth between 2000 and 2010
will be the largest of all the energy sectors from 324 Mt in 2000 to 445 Mt
in 2010 under the moderate scenario and to 490 Mt under the optimistic
scenario. Moreover, it will exceed the overall growth rate of Russias GDP
up to 20072008, contradicting the Russian Governments intention to
diminish the dependence of GDP growth upon exports and energy
resources. All these facts raise doubts among many experts in Russia.
Given that internal consumption of oil has been stable for the last
six years (about 175180 million tonnes) and there will be no sizeable
increase in consumption during 20002020 (according to the Strategy,
p.66), it follows that the proposed substantial growth in oil extraction
is to be exported.
At the same time, the recent trend in oil exploration and production
do not suggest much future increase in oil production. Moreover, the
volume of exploration drilling, which, to a great extent, should be the
evidence for any future trend in oil production, declined during
20012002. According to Ministry of Energy, the volume of production
drilling decreased by 16.8 per cent in 2002 compared with 2001 and the
volume of exploration drilling dropped by 40.1 per cent.
Apart from that, the depreciation of existing oil wells reached 53 per
cent (43 per cent in Western Siberia) (Russian Strategy on Nuclear
Energy Development), which resulted in a decreasing rate of oil
production. At the same time, the productive potential of new oil wells
is significantly lower than old ones and the proportion of oil wells with
difficult access is about 60 per cent of the industry total and continues
to grow.
144
Market Potential
Gas production
The Strategy forecasts a significant increase in gas production by 2020,
from 584 bcm in 2000 to 730 bcm (or 680 bcm under the moderate
scenario). There are concerns among energy analysts as to the ability of
gas producers to accomplish this task. Since the collapse of the Soviet
Union in 1991, investment in the Russian gas industry, particularly in
gas extraction, has fallen sharply. A decline has begun at Gazproms
three main fields, which accounted for 78 per cent of production in
2001. The rate at which they will decline in the future is unknown, as is
the speed with which new capacity can be developed to replace the old
fields. There are two main obstacles. First, because of their arctic
location, there will probably be a lag of at least five years between the
commencement of a project and the first significant extraction of gas.
Second, at present Gazprom is in no condition financially to begin
these projects.
Electricity production
The Strategy forecasts a gradual increase in electricity production
from 878 billion kW in 2000 to 1,215 billion kW (under the moderate
scenario) or to 1,365 billion kW (under the optimistic scenario) in 2020.
This is to be achieved by raising thermal energy production (40 per
cent), through increased use of coal (see discussion above). In addition,
production of nuclear energy is to double.
Investment constraints
The Russian Energy Strategy to 2020 calls for massive investments in
the energy sector over the 20032020 period (see Table 3.5.1).
Table 3.5.1 Energy sector investment requirements by industry to
2020 ($bn)
Industry
Strategy
(2000)
Strategy
(2002)
Current
Strategy (2003)
% change
2003/2002
Oil
Natural Gas
Electricity
Coal
Heating
Energy Efficiency
Total
159197
164171
147217
18
n.a.
n.a.
488603
150
180
130160
2029
n.a.
n.a.
480519
230240
170200
120170
20
70
5070
660770
+53 to +60
5 to +11
8 to +6
0 to 31
+38 to +48
Source: Russian Energy Strategy to 2020 (various versions)
145
As Table 3.5.1 shows, there have been substantial changes in energy

sector investment requirements envisaged in the last version of the
Strategy, resulting in a significant increase of both total investment
requirements and investments for the majority of energy industries. It
is now projected that the Russian energy sector will require $3338
billion investment per annum between 2001 and 2020, which is double
what the Russian energy sector obtained in 2002 (about $16 billion)
and half of aggregate investment in the Russian economy in 2002
(about $70 billion). The most dramatic increase in investment requirements is in the oil sector, which needs a third of the total investment in
Russias energy sector ($230240 billion between 2000 and 2020 or
$1112 billion per annum).
Such optimistic forecasts of investment in Russias energy sector
raises doubts both on the general ability of the Russian economy to
attract such investments and on the energy industries finances. In
general, the poor investment climate in Russia will continue to hinder
foreign direct investment. The current investment environment is
characterized by fiscal, legal and regulatory instability and by a significant lack of transparency.
Besides, given the Russian Governments experience with regulation of the national economy (ie employing direct mechanisms such
as tax or custom duty privileges, decrease in rent payments, zerointerest bank credits, budget financing for some projects, etc), some
Russian analysts (in particular, ISDEI) suggest that projected investments will have a negative impact on the whole economy by redirecting
financial capital from non-energy sectors (with higher value added) to
the primary industries.
3.6
The Telecommunications
Market
Vyacheslav Masenkov, Deputy GeneralDirector and Alexander Chachava, Senior IT
Analyst, RBC
General description of the market

Unlike other industries, the Russian telecommunications market is
quite mature, and it keeps on developing. The Russian communications
industry has lived up to expectations. There has been a boom in both the
cellular telecommunications segment and elsewhere throughout the
industry, with major telecom projects now underway.Alternative telecom
operators have secured the bigger share of the market, offering their
customers advanced technologies. Very soon multimedia, telematics and
other services will become something commonplace and will be available
through multifunctional smartphones. The main problem, however, is
too fast a technological growth that makes returns on recent investment
hard to earn quickly. At the same time, while these innovations are
intended for residents of large cities, rural areas would probably be
happy to settle for a mere three TV channels, to say nothing of MMS.
What was left from the Soviet Union was a telecom network that was
much better than in some countries with a similar level of national
welfare. What hampers telecoms development in the country are such
weak points of the central network as lack of long-distance communication lines, outdated switches (although this problem is now almost
solved), and obsolete local networks, which are often in poor condition.
Russia is distinct from Europe and most Asian countries, where the
industry is dominated throughout by former monopolies, in that its
telecom industry is decentralized. This could be said of the USA as well,
but that countrys network was split up after it had been integrated to
cover the whole US territory. In Russia, this industry structuring
approach leads to considerable differences in the level of services. For
147
instance, leaders among alternative operators, such as Sovintel and

Comstar, do offer state-of-the-art services, but only large corporate
customers can afford them. The rest have no choice but turn to cheaper
services that are often of poor quality.
The situation in the telecoms market has changed for the better
recently owing to the policy pursued by the Communications Ministry
and the Ministry for Economic Development and Trade, private
companies, and also Russian and foreign investors. The biggest operators rely on latest technologies to upgrade their equipment, expand
product lines, diversify services by adopting future-oriented technologies, and capture new markets.
Volume of the telecommunications market

The telecommunications market accounts for a major share (72 per
cent) of the national IT industry sales that were assessed at $12.13
billion in 2002 (see Figure3.6.1).
software
5%
services
7%
equipment
16%
telecommunications
72%
Source: www.ibusiness.ru
Figure 3.6.1 Market shares of information technologies (experts

assessment)
Telecommunications is the biggest and, in some segments, the communications industrys fastest growing market. It is quite a successful
business, according to the Communications Ministry, with a turnover
of $8.7 billion in 2002, up from $6.7 billion in 2001. The year 2003 is
expected to see a 40 per cent gain. Russia controls about 0.7 per cent of
the world telecommunications market. Experts forecast a further
increase in the telecoms share of GDP from 2.5 per cent in 2002 (see
Figure 3.6.2). The corresponding figure in Western Europe and North
America stands at 46 per cent of GDP.
The industrys economic results in 2003 were impressive. In the first
six months, the range of services grew by 50 per cent from a year before.
148
Market Potential
3.0%
2.5%
2.40%
2.10%
2.50%
2.0%
2.10%
1.5%
2%
1.0%
0.5%
0.0%
1998
1999
2000
2001
2002
Source: Communications Ministry, RosBusinessConsulting
Figure 3.6.2 Communications industrys share of GDP (%)

Small wonder that foreign companies have an incentive to invest in the
Russian telecom market. In particular, over the first nine months of
2003, foreign investments had climbed to $575.2 million, a 43.1 per cent
gain on the same period in 2002, of which direct investments amounted
to $73.4 million, portfolio investments totalled $18.8 million, and $483.1
million were other investments. Besides that, some $800 million of
domestic capital was invested in the industry over the same period.
Thus, more than $7 billion has been invested in the Russian telecommunications industry over the past four years. The trend is expected to
continue in 2004, with emphasis placed on development of cellular
telecommunications in regions and expansion of services offered.
Since different segments of the market often overlap, the market is
hard to assess by merely summing them up. An objective assessment of
the aggregate volume of the telecommunications market can be made
based on an estimate of the communications industry as a whole. The
telecoms equipment segment occupies some 81 per cent of the market,
while the share of telecom services is 19 per cent.
The share of telecoms equipment in the total volume of the segment
is quite small because investments are closely linked to technological
innovations. To adopt new technologies, operators have to invest large
sums in equipment that will pay off in several years. According to
experts, there will be no more major investments in the cellular
telecommunications segment; while the 3G technology is yet to come to
Russia, the more so because it is not yet as profitable in Europe as
expected. In 2002, Europe found itself in a situation where 3G technology was unnecessary. As a result of the regulators miscalculation,
market growth slowed down, players changed, and traditional operators such as Deutsche Telekom and FranceTelecom suffered losses,
while new operators such as Vodafone emerged. Europe is not,
however, going to remain static in this situation for long.
1,277.1
3,413.9
248.7
255.0
98,330.1
32.4
* No comparisons can be made between the structure of services in 2002 and 2003
Source: Communications Ministry
Radio frequency centres
23,252
400.7
Intelligent network services
Connection and traffic transmission

services
425.1
ISDN services
100,154.3
1,893.6
Mobile telecommunications
9,060.1
Wire broadcasting
7,041.7
13,680.7
17,992.4
Recording communications*
Radio communications, radio broadcasting,

TV and satellite communications
83.3
155.5
3,896.8
2,069.1
13,425.8
13,529.6
Rural telephone service
47,966
796.7
150,993.5
New
All types of payphones
53,033.6
Urban telephone service
850.3
19,383
281,654
Total
Long-distance communications
Special communications
Mail service
Total operating revenues, including
Index
1,277.1
19,838
152
170.1
1,824.2
1,861.2
2,018.4
4,311.7
1,913.6
3,813.5
34,540.2
39,504
850.3
18,586.3
130,660.5
Traditional
Operators
JanuarySeptember 2003
154.3
161.1
115.1
138.3
133.9
129.8
106.4
120.4
137.9
148.9
Total
161.8
114.8
147.8
161.6
167.3
101.4
175.7
155.0
New
154.3
129.2
115.1
113.0
133.4
119.4
108.3
120.4
136.6
142.4
Traditional
Operators
Gain over same period in 2002, %
Table 3.6.1 Communications industry indicators (JanuarySeptember 2003), in millions of roubles

149
150
Market Potential
Key players in the telecommunications market

Russian telecom operators can tentatively be divided into three
groups: traditional, institutional and new (alternative).
Traditional telecom operators

Traditional operators are companies that provided telephone and telegraph services before the 1990s, and continue to do so today. These
include companies more or less controlled by OAO Svyazinvest, MGTS,
Lensvyaz, the Komi Republics Svyaz, and the largest interregional
operator, Rostelecom.
The authorities influence has a dual effect on investment prospects
in such companies. On the one hand, they cannot avoid bearing social
responsibilities in their areas, quite often holding enormous debts
owed to them by government agencies and other public sector entities
that cannot be left without telephone communications.
On the other hand, traditional operators have the most extensive
networks and are monopoly operators in an overwhelming majority of
regions, which guarantees them regular minimum incomes regardless
of economic conditions or the political situation, given a steady demand
for telecommunications services.
The telecom rate setting powers have recently been transferred
from local authorities to the Antimonopoly Policy Ministry to minimize
regional authorities influence on local companies. The pricing policy
has become more predictable and economically sound, and political
considerations have become less overbearing.
Institutional telecom operators

Institutional telecom operators have traditionally provided services to
enterprises of the transport industry, oil and gas industries etc, and
were controlled by the respective ministries. The major institutional
operators are Transtelecom (Ministry of Railways), Gazsvyaz,
Gaztelecom, Gazcom, UES Telecom, Macomnet, and Metrocom.
Alternative (new) telecom operators

Development of the telecom industry has given rise to a great number
of alternative operators. Initially, most of them were joint ventures
with a big share of foreign capital. Subsequently, following mergers
and takeovers, many companies became fully-fledged Russian-owned
businesses. Today alternative operators control almost 100 per cent of
the mobile communications market, a considerable share of the
Internet access services market, and a big share of telephone communications services, particularly those they provide to corporate
151
customers. In 2002, the aggregate sales of services provided by alternative operators in Moscow exceeded the revenues of traditional
communications operators.
The main advantage of alternative operators is a high quality of
communications, wide range of services, and no burden of social responsibilities. Most alternative operators use public telephone networks of
traditional operators, and many of them build digital overlay networks
providing voice mail and high-speed data transmission services.
Major alternative operators include Golden Telecom (OOO SCS
Sovintel), ZAO MTU-Inform, ZAO Combellga, OOO Ekvant, ZAO
Transtelecom Company, ZAO Comstar, ZAO Peterstar, ZAO MTUIntel, OAO Central Telegraph, OAO RTComm.RU, ZAO Telmos, and
OAO Komincom.
In December 2003, Golden Telecom bought from Norwegian Telenor
100 per cent of shares in OAO Komincom, the sole owner of ZAO
Combellga, in exchange for its stock. The merger, which is expected to
be completed within 12 to 16 months, will produce one of the largest
alternative telecom operators in Russia. Alfa-Bank will have 30.02 per
cent in the stock of the new company, Telenor will get 19.5 per cent,
Rostelecom 11.2 per cent, European Bank for Reconstruction and
Development 8.4 per cent, Barings 7.2 per cent, Capital International
6.1 per cent, and the remaining shares will continue to be traded
openly. By taking over Komincom-Combellga, Golden Telecom aims for
synergies, especially in the regions.
Leaders in the Russian telecommunications market

According to 2002 performance results, MTS topped the list of Russias
major telecom operators, ahead of long-distance communications
operator OAO Rostelecom, with OAO VimpelCom edging up closer to
the leaders.
In July 2003, the number of cellular phone users in the GSM,
TDMA/DAMPS, NMT, IS-95 and IMT-MC-450 standard networks
reached 27.01 million (according to Json&Partners), and by the end of
December 2003 the figure had jumped to 33.5 million. The overall
cellular phone penetration rate in Russia is 18.6 per cent. In Moscow
and the Moscow oblast that exceeds 56 per cent, St. Petersburg and the
Leningrad oblast trail with 45 per cent.
Telecom operators in the stock market

Russian telecom operators have made considerable headway in the
stock market for two years in succession. This fact can, to an extent, be
attributed to the favourable situation in the stock market. Yet the operators improving operating and financial performance is not to be overlooked.
152
Market Potential
Table 3.6.2 Major telecom operators in Russia

Company
Sales, $ million***
2002
2001
MTS***
VimpelCom***
MegaFon (consolidated)
Rostelecom
Uralsvyazinform*
Tsentrtelecom*
VolgaTelecom*
Sibirtelecom*
UTK*
MGTS
North-West Telecom*
Transtelecom**
Dalsvyaz*
Sovintel
Central Telegraph
Bashinformsvyaz
Svyaz (Komi)
Lensvyaz
Kazan GTS
1,361.8
768.5
409.0
810.2
471.7
522.6
349.7
389.4
335.8
322.1
321.8
40.4
170.0
145.0
40.2
73.1
35.5
335.0
12.5
893.2
422.6
215.0
638.0
337.3
424.7
278.1
318.0
271.2
263.4
266.3
6.9
139.9
116.9
24.9
65.0
30.1
28.2
8.2
2002 on 2001
% change
52.5
81.9
90.2
27.0
39.9
23.1
25.8
22.4
23.8
22.3
20.8
485.5
21.5
24.0
61.3
12.5
17.9
18.7
51.8
* Aggregate turnover of amalgamated operators

** Telecoms services sales
*** Consistent with GAAP
Source: company reports, RBC
Table 3.6.3 Major cellular telecommunications operators in Russia

Operator
Subscribers in
August 2003
MTS
VimpelCom
MegaFon
SMARTS
Uralsvyazinform*
NSS
Tomsk Cellular Communications
Eniseitelecom
Ekaterinburg-2000
Sibchallenge
9,910,000
7,950,000
4,645,350
860,000
837,373
268,142
169,926
160,486
155,699
138,000
* Consolidated data
Source: IAA Sotovik
Subscribers gain since

January 2003, %
49
54
57
59
67
56
68
111
96
119
17.90
7.32
5.48
Lensvyaz
Kazan GTS
Central Telegraph
Source: Companies data and RBC data
20.28
Svyaz (Republic of Komi)
UTK
73.08
259.79
North West Telecom
Bashinformsvyaz
277.07
Sibirtelecom
84.11
341.12
VolgaTelecom
Dalsvyaz
460.30
443.98
Tsentrtelecom
570.78
MGTS
1,266.11
Rostelecom
725.11
2,561.09
VimpelCom (GAAP)
Uralsyazinform
5,880.31
July 2003
9.44
9.15
17.90
16.74
31.45
16.76
72.47
184.49
61.56
78.76
101.61
482.97
85.25
728.33
1,147.29
2,475.49
July 2002
Market value, US$ millions
MTS
Company
0.009
0.003
0.065
0.058
0.239
3.799
7.777
4.465
11.866
10.490
11.381
2.273
106.510
2,480.739
0.494
n/a
Trade volume
from 01.07.02
to 30.06.03,
$ millions
Table 3.6.4 Russian telecom operators in the stock market
1.40
3.36
3.31
4.45
26.19
12.36
73.17
20.89
29.19
63.42
52.30
40.67
43.93
168.43
178.00
427.30
Pre-tax profit,
$ millions
0.74
0.042/0.042
0.005/0.1
3.938/11.814
2.50
2.59
0.1222/0.0407
0.025/0.02
0.31/0.58
0.081/0.161
0.064/0.14
0.007/0.012
0.706/1.795
0.096/0.206
0.68/7.055
3.68
19.99
5.89
49.76
10.43
15.09
46.90
34.55
35.89
n/a
0.543/1.27
98.62
28.97
n/a
1.7/-
Dividends on
stock (ordinary/
preference) in
2002, Rb
130.00
277.10
Net profit,
$ millions

153
154
Market Potential
The stock prices of traditional and alternative telecom operators have

risen dramatically. Specifically, in the first half of 2003, growth rates
varied between 70 per cent and 100 per cent. Among the factors
contributing to the increase in the companies capitalization value are
improvements in their financial performance, greater transparency,
growth in business activity in Russia, mergers of telecom companies,
recent changes to Russian laws and rapid development of the world
stock market for high-tech companies shares.
The shares of traditional telecom operators have grown more
expensive following reorganization of Svyazinvest JSC and mergers of
numerous regional companies into seven interregional communications firms. Factors contributing to the increase in stock prices include:
growth in the liquidity of the companies stocks as new shareholders
have become more active after their stocks were converted from
shares in former communications companies and following an
increase in the number of shareholders;
aggressive activism of Western investment trusts. Following
mergers, the new companies investment risks have fallen dramatically, with little effect on the companies capitalization until
recently;
availability of foreign capital. The rationale behind the mergers of
communications companies was to boost their capitalization figures
by entering international capital markets. Some of the operators
have already announced their intention to implement Level Three
ADR programmes.
In 2003, traditional operators did their best to slow down the decline of
their market share. Svyazinvest group operators launched reorganization of business and investment planning patterns in an effort to
enhance transparency of the business and facilitate development of
strategic plans on the competitive market. Enhanced solvency was one
of the most immediate favourable effects of regional operators
mergers. This development has enabled the operators to lower interest
rates on investments and to increase the volume of investment funds.
The AKM-com index, which can be considered an indicator of the
industrys stock position in the market, grew by 52.4 per cent from
January to December 2003. In 2002, the operators stocks, too, saw a
certain growth, although the yearly growth was half as fast, giving a
gain of 25 per cent. Telecom operators shares were only less attractive
than those of energy and metal producers.
The fastest growing shares in the period under review were the ordinaries of Uralsvyazinform (+100 per cent), which are slightly less
attractive than those of Rostelecom in terms of liquidity. Today
Uralsvyazinform is not only a fast growing company in the Perm region,
155
but also an operator in Russias oil-rich regions boasting the countrys

highest GRP and per capita incomes. Moreover, Uralsvyazinform is
more than just a fixed telephony monopolist in the region, it is also
Russias fourth largest operator for the number of cellular telecommunications subscribers. In this area, Uralsvyazinform is more profitable
than any other Svyazinvest company.
Table 3.6.5 OAO Svyazinvest operators stock prices in January to
December 2003
Operator
Ordinaries
growth rate, %
Preferences
growth rate, %
Uralsvyazinform
VolgaTelecom
Rostelecom
Dalsvyaz
Sibirtelecom
Tsentrtelecom
UTK
North-West Telecom
100.6
88.7
60.3
40.0
23.0
21.7
19.5
11.1
62.3
70.5
53.0
30.0
42.8
33.4
38.4
Source: RTS
VolgaTelecom was another fast growing operator (+88.7 per cent). It

plans to consolidate and develop its cellular telecommunications
assets, the announcement of which has had a favourable effect on the
stock market.
Rostelecom shares grew by 60 per cent, which is a sign that it is
attempting to fight off growing competition from alternative operators.
Telecom operators shares will remain just as attractive in 2004.
However, existing risks have a depressing effect on their popularity.
Small wonder, buying Svyazinvest operators shares is a risky
business, but, as happened before, may turn out to be quite profitable.
One can safely assume today that the Russian Federal Property
Funds plan to sell the government stake in Svyazinvest (or any part of
it) will not come off even though the plan has not been dropped yet.
Nothing is known about many of the terms and conditions of this transaction, in particular, the date of the auction has not been set, potential
buyers are unknown (bidders are generally believed to include AlfaGroup, Sistema JSFC and Telecominvest Holding Company), nor are
the conditions of the sale. Market players are expecting more certainty
about Svyazinvest privatization prospects in 2004. Moreover,
investment projects will be accumulated along strategic lines, which
will give the market a benchmark to assess the operators market
value.
156
Market Potential
Equally important for the financial performance of Svyazinvests

interregional companies in 2004 is a possible rise in tariffs on local
communications, expected to increase by 1820 per cent in the second
half of 2004.
Market for communications facilities

According to the Russian Communications Ministry, the volume of the
domestic telecommunications equipment market totalled about
$3.33.4 billion in 2002 and it is expected to grow to $6.3 billion by
2010. The report prepared by the Russian Ministry of Communications
also profiles the structure of the communications equipment market. It
is hard enough, however, to get an idea of the kind of equipment the
Communications Ministry implies in, for instance, the mobile communications line of its report.
More specific data are given in surveys carried out by telecommunications equipment suppliers. For instance, according to Alcatel,
equipment sales for purposes of developing the Russian communications infrastructure accounted for about 1.4 per cent of overall international sales in 2003. According to data provided by Gartner, these
estimates give a market capacity of $1.61.8 billion for this equipment
class. As the company says in its study, the overall equipment sales for
operators and corporate networks will total $2.2 billion in 2003.
According to the Russian Goskomstat (State Statistics Agency),
manufacture of communications equipment in Russia grew by 30.6 per
cent in January to August 2003, up from the same period in 2002. The
range of communications equipment, on which statistics is available, is
quite interesting: while radio sets, TV sets, and telephones can typically be classified as communications equipment, VCRs can hardly be
regarded as such. The fact that VCRs were included in this category
must be due to their considerable growth rate of 82.9 per cent, which
has had a positive effect on overall statistics.
Foreign manufacturers dominate in most communications equipment
market segments, and despite official reassurances (from the Russian
Ministry of Communications, etc) there are no viable prospects for a
significant increase in the market niche held by domestic suppliers.
Experts believe, however, that telecommunications equipment from
Russian manufacturers could be in demand in small market niches.
For instance, domestic developers stand the best chance in the
physical line modem segment. This segment comprises such Russian
companies as the Kroniks Design Office, Zelaks, the Nateks Centre for
Science and Technology, NSG, Granch, etc. Their equipment was
initially designed for Russian communications lines, taking into
account their specificity as early as at the development stage. The line
157
of their products spans almost all existing digital subscriber line technologies, except for the ADSL technology, which is almost 100 per cent
foreign-made modems.
Rotek, one of Russias flagship telecommunications equipment manufacturers, boasts high achievements in optical equipment. At the recent
TRBE 2003 show, Rotek displayed a CWDM (Coarse Wavelength Division
Multiplex) system designed, first and foremost, to transmit a great
number of video and audio signals via a single fibre of an optical cable.
At the present time, new services considerably increase line load
capacity and adversely affect performance of obsolete equipment.
Almost all telecommunications operators today face the prospect of
developing and upgrading (digitalizing) their telephone exchanges,
modifying their layouts, and replacing obsolete equipment throughout
vast regional networks. As of early 2003, only 26 per cent of the
hardware used in the Russian telecommunications sector met international requirements. Almost three-quarters of existing communications networks are to be modernized in the next few years in order for
Russian communications networks to operate efficiently.
The share of digital channels operating in the primary public communications network had grown to 83 per cent by early 2002. Relatively
new and small-size telephone exchanges are the most digitalized option.
The Khantymansiyskokrtelecom Company operates the most advanced
network, at a digitalization level that had reached 88.6 per cent by early
2002. Meanwhile, MGTS has the smallest number of modern automatic
telephone exchanges, at a digitalization level of 11.43 per cent.
9000
8000
777
other services (9%)
605
document
telecommunications and
new services (7%)
2,803
cellular communications
(33%)
US $ million
7000
643
374
6000
5000
543
254
4000
3000
2000
407
1,278
749
202
201
1,915
295
253
2,244
1,862
415
421
1,364
1,211
833
1,084
1,380
1998
1999
2000
2001
trunk and international

telephone communications
(26%)
1,649
1000
radio communications,
broadcasting, television, and
satellite communications
(4%)
1,798
urban and rural telephone

communications (21%)
2002
Source: Russian Ministry of Communication
Figure 3.6.3 Russian telecommunications market segments
158
Market Potential
Cellular telecommunications
According to Alcatel, the cellular telecommunications segment, which
has always been the driving force of the telecommunications market,
accounted for about two-thirds of the 2003 overall operator-class
equipment sales. The cellular phone segment, in which the 2003 sales
are expected, according to available studies, to top $1 billion in Russia,
should be taken into consideration on its own merits.
The cellular phone boom currently underway in Russia gives the
numerous cellular phone manufacturers and cellular telecommunications equipment suppliers a good opportunity to make high profits.
Besides, next generation cellular networks, including IMT-MC-450
standard networks (CDMA-450 technology), are currently under development, with the US Lucent Technologies, the Canadian Nortel
Networks, and the Chinese ZTE Corporation and Huawei Technologies
being the key bidders for supply contracts.
In the equipment market, fast absorption of small-size cellular
telecommunications companies has resulted in this market being now
dominated by the Big Three operators accounting for 90 per cent of the
overall sales of relevant equipment. At the same time, the companies
taken over in the process are capable of expanding their operations by
attracting more customers by offering the low prices of their parent
companies, while the remaining small-scale independent operators are
forced to slash investments, being unable to compete with the big players.
Fixed communications facilities

In the past four years, the Russian fixed communications equipment
market has grown 3.6-fold. According to various estimates, the total
Others
19%
Nokia
20%
LG
6%
Siemans
18%
Alcatel
11%
Motorola
13%
Samsung
13%
Source: RBC
Figure 3.6.4 Cellular phone sales structure in 2002 (legitimate sales)

(%)
159
cost of new automatic telephone exchanges sold in Russia in 2002

equalled $150$200 million. In terms of monetory value, though, the
market has changed little: while sales rose, equipment prices dropped.
The overall cost of maintaining, expanding and upgrading the
hardware already installed equals $3040 million.
Unlike the steadying mobile communications segment, the fixed
communications equipment market is going through its most critical
period in the recent decade: traditional operators have for the first time
been largely replaced by cellular networks in the voice communications
segment, in a process that has been facilitated by both reciprocal trends
in price policies and an almost complete federal coverage by, and also easy
connection to, GSM networks. Traditional operators have already been
confronted by the prospect of choosing between the two business areas
when planning investment expansion in the most developed regions, for
instance, the Ural region. Should Svyazinvest be privatized, the new
owner will also have to think twice about the need for a massive
replacement of obsolescent equipment that is still fit for operation.
Despite the gains made by US and Chinese manufacturers in the
Russian telecoms equipment market, Siemens and Alcatel are likely to
remain leaders in the fixed communications market in the near future.
Although no drastic leap is expected in demand for automatic telephone
exchanges in local communications networks in Russia, a considerable
increase in automatic telephone exchange capacity is clearly in
evidence. In 2002, Svyazinvest took out its highest-ever loan, a
centralized credit of four billion roubles from Sberbank (Savings Bank),
to purchase equipment for regional operators, and the year 2003 will
see the greatest number of digital telephone exchanges put into service.
The Internet
As of early 2003, Russia had about 3.5 million active Internet users,
whose numbers registered an annual growth rate of 4050 per cent.
The overall number of Internet users, going online at least once in
several months, equals about 10 million. The data transmission, telematics and Internet equipment market segment has the greatest
potential for dynamic growth.
Satellite communications
The Russian satellite communications market is yet to be developed. The
Kosmicheskaya Svyaz Federal Unitary Enterprise, which owns ten satellites, provides the bulk of all satellite communications services. At the
moment, Kosmicheskaya Svyaz is primarily responsible for broadcasting
federal television channels and providing presidential communications,
and now the company plans to digitalize and compress television
signals, which will enable it to free up some of its satellite channels and
160
Market Potential
Table 3.6.6 Communications equipment statistics

Communications equipment
Telephones (including office exchange

telephones),total, including:
Urban and rural communications
network telephones, total,
of which operated by traditional
operators
Main urban and rural communications
network telephones
networks apartment telephones
network telephones, linked to
office telephone exchanges, total
operators
All types of payphones, total
of which by traditional operators
of which phone card-operated
Trunk (international) payphones,
total
operators
network payphones
operators
network general-purpose
payphones
Main radio relay stations, total
Mobile communications, total
subscribers
of which serviced by traditional
operators
Including cellular
telecommunications subscribers
of which serviced by traditional
operators
Telematics and data transmission
services, total subscriber sets
Including Internet subscriber sets
Source: Russian Communications Ministry
As at
1 October
2003
2003 on
2002, %
Gain
(loss) in
nine
months of
2003, %
37,502,353
104.73
3.5
36,452,867
104.64
3.6
32,377,962
104.72
3.2
35,244,972
104.94
3.7
28,541,930
105.26
3.6
1,049,486
107.97
0.5
879,462
188,622
165,918
132,868
99.99
95.35
91.86
109.63
2.2
2.2
2.7
6.7
7,409
73.47
33.7
7,126
73.37
35.9
106,400
82.36
6.1
97,590
81.54
6.6
74,813
19,615,852
30,418,894
127.76
92.24
219.25
11.6
5.7
42.2
637,888
177.74
33.4
29,890,499
221.19
42.6
469,664
199.77
39.4
3,437,442
3,173,438
189.00
194.18
35.3
37.1
161
use them for commercial purposes. Two other operators, namely

Gazcom and Voentelecom, which provide services to Gazprom and the
Russian Defence Ministry, respectively, are also exploring the feasibility
of going commercial. Cellular mobile satellite communications are
provided by Globalstar and Thuraya. Globalstar has a total of about
8,000 users, and Thuraya has just started providing such services.
Corporate Intranet equipment

Institutional communications operators have been established to
provide intranet communications to large industrial holding companies,
ministries, and government agencies. This market segment is specific in
that its consumers comprise establishments of various ownership
patterns: government agencies, corporate organizations represented by
natural monopolies with a considerable share of government presence
(such as the Gazprom Gas Company and the Unified Energy System), or
their specialized subsidiaries, and private corporate operators.
The communications networks of various government agencies and
corporate organizations in the fuel and energy and transportation
industries, and also other government agencies, offer large niches for
telecommunications manufacturers. Particularly fast growth rates
have recently been registered by communications networks of the
Russian Ministry of Railways.
Well-known foreign companies and domestic enterprises (claiming
2530 per cent of overall supplies) are the main hardware suppliers for
this market segment.
Switching equipment manufacture

The capacity of the market for switching equipment for institutional
and corporate communications networks may be compared to that of
the local public communications network (6575 per cent).
Switching equipment manufacture is one of the areas, in which the
domestic industry maintains a significant potential. The Russian
Table 3.6.7 Demand for switching equipment for establishing an
interlinked communications network in Russia in 20012010
Communications network type
Millions of
numbers
$ billion
Local urban communications

Local rural communications
Mobile communications
Total demand
2426
34
2325
5055
2.42.5
0.30.4
2.73.0
5.45.9
Source: Russian Ministry of Communications
162
Market Potential
Ministry of Communications promotes the domestic industry, even

though most production facilities are owned by foreign companies that
have succeeded in obtaining the status of domestic manufacturers in
Russia.
Russian companies and Russian-foreign joint ventures having the
status of domestic manufacturers have developed and launched into
production of a wide range of digital automatic telephone exchanges,
which meet modern technological standards.
The total output of switching equipment produced by domestic
manufacturers may reach 4.55 million phone lines a year. This figure
considerably exceeds the annual rate of phone numbers introduced by
public telephone networks. Most existing production capacities remain
untapped. This fact has a direct impact on the profitability of products
manufactured and manufacturers themselves.
In the first half of 2003 the local telephone network capacity grew by
about 1.5 million ports. The domestic industry, primarily joint ventures,
sold 6070 per cent of all equipment in service. The remaining
equipment required to install these port numbers was delivered by
foreign companies such as Siemens, Alcatel, Ericsson, and so on.
Demand for cellular, trunk and international, and most of the corporate
communications equipment is almost fully satisfied from imports.
There are two ways to meet demand for switching equipment. The
first is to purchase new hardware, and the second is to upgrade existing
equipment, still with much service life left, so that it could efficiently
meet modern requirements made on equipment by the Russian
Interlinked Communications Network. Given relatively low costs (3040
per cent of the cost of new equipment per port), modernization will allow
the service life of most switching equipment to be extended, and in individual cases it will even allow for increasing the phone number capacity
of communications networks operating on existing equipment.
At the present time, requirements made on switching equipment are
being revised thoroughly. The traffic structure is shifting from voice
information to data transmission. This suggests the need to make
drastic changes to switching equipment, namely, effecting a
changeover from channel switching to packet switching. This is a timeconsuming process, however, and so channel switching will remain in
demand for some time to come.
Government regulation of communications

equipment manufacture
Communications equipment is manufactured under government
supervision. Most future-oriented science-intensive developments
have been carried out in compliance with the federal target
163
programme Development of Telecommunications, Television, and

Radio Broadcasting Equipment. Baseline development was supported
simultaneously with commercialization of the results of the federal
target programme Electronics Development in Russia.
The capacity of the domestic industry at the first and second stages
(until 2006) will primarily depend on the impact of the launch of new
equipment designed in compliance with the above programmes into
production. At the third stage, the domestic industry is to introduce
technologies and manufacture equipment developed under federal
programmes adopted by the Russian Government, such as Basic
National Technologies and Electronics in Russia.
These programmes set guidelines primarily for traditional
equipment developers and manufacturers. A significantly larger
number of companies are making attempts to stay on in the equipment
market on their own, often at the risk of unjustified expansion of the
range of identical equipment manufacture.
The Conception for Developing the Russian Telecommunications
Equipment Market in 20022010 adopted by the Russian Ministry of
Communications is aimed at protecting the domestic telecommunications equipment market, supporting Russian manufacturers in
availing themselves of their competitive advantages, and raising the
share of domestically-manufactured equipment in the domestic
communications equipment market to 6065 per cent. At the present
time, it is imperative to create conditions for developing new types of
equipment and new technologies, channelling investments into the
industry, and establishing new, and upgrading existing, workstations.
The Conception also deals with laws and statutes regulating the
market for telecommunications equipment and communications
services.
3.7
Telecommunications:
The Regulatory
Framework
CMS Cameron McKenna
Introduction
Rapid developments in technology and the growth of the Internet are
among the drivers of fundamental change in the structure of the old
telecommunications, broadcasting and media industries across the
world. Russia is no exception. The Internet, mobile, telephony and
digital broadcasting are likely to grow at exponential rates, although
starting from a comparatively low base. Significant investment is still
needed in the public service telephone network if penetration rates are
to be lifted from the current national average level of 21 per cent to the
target level of 60 per cent, which has been set by the Ministry of
Communications and Information Science. The Ministry has calculated that some $60 billion of investment in telecommunications will
be required over the next 10 years to achieve this.
Privatization
Until 1993 the Russian telecommunication network was fully
controlled and owned by the state authorities of the Russian
Federation. In 1992 the Russian government announced plans for
privatizing the telecommunications sector and local network operators
were privatized according to the following scheme: 51 per cent of
common shares were kept by the State; 5 per cent were transferred to
the companies management; 10 per cent were transferred to the
companies themselves; 25 per cent were transferred to the employees
as preferred shares; and the remaining shares were sold by the local
state property management funds to investors. Later the government
165
formed a holding company, Svyazinvest, which owned all government

shares in all regional telecommunications companies. Currently, each
subject of the Russian Federation has its own telecommunications
company. These companies tend to suffer from regulated low tariffs but
enjoy a monopoly position in their respective regional markets.
The government developed a two-stage scheme to privatize part of
Svyazinvest. In July 1997, 25 per cent of the capital plus one share in
Svyazinvest was sold for $1.875 billion. The second step of privatization (25 per cent minus two shares) was postponed owing to poor
market conditions after the financial crisis in 1998. Subsequently, the
second step of privatization was postponed again pending the termination of the reorganization of the company; this should significantly
increase its capitalization.
Rostelecom is Russias main international and long-distance
telecommunications carrier. Svyazinvest currently owns 51 per cent of
Rostelecom. Other strong players on the Russian telecommunications
market are the state-owned natural monopolies, such as the Ministry of
Railway Transportation, Gazprom and RAO Unified Energy Systems,
which use their infrastructure networks for telecommunications
business.
Legal regulation
The general principles of Russias telecommunication legislation are
set out in the Federal Law on Communications dated 17 July 2003,
which came into force on 1 January 2004. It sets out a legal framework
for the rapidly developing telecommunications industry and is
intended to stimulate investment in the telecommunications sector, as
well as to foster competition among local telephone operators in the
sector, which is monopolized in some spheres.
Governing agencies
The principal ministries and committees that have jurisdiction over
telecoms operators and equipment suppliers are set out below.
The agency responsible for regulating the telecommunications
market is the Ministry of Communications and Information Science of
the Russian Federation, which in turn is responsible for a number of
state committees that have delegated authority in relation to specific
areas. The Ministry is responsible for state policy and state
management of the communications industries, including postal and
courier services. The Ministry also manages a number of state enterprises operating in the telecommunication sphere and is responsible
for issuing licences to telecoms operators. The Ministry supervises, on a
166
Market Potential
day-to-day basis, telecoms operators and has the power to inspect

equipment and generally monitor compliance with licence terms.
A number of other state agencies and institutions have authority
over the telecommunications sector. The Federal Agency for
Government Communication and Information certifies and licenses
the use of encryption codes and equipment. Jointly with the Ministry of
Anti-Monopoly Policy, the Ministry of Communications and
Information Science develops and coordinates tariffs and tariff policy
for the telecommunication services. The State Committee for Radio
Frequencies assigns radio frequencies, monitors the use of frequencies,
and defines technical standards in broadcasting. The State
Commission on Electronic Communication coordinates the development and construction of telecommunications networks and systems
and supervises their operations. The State Commission on Information
Science is responsible for state policy in the sphere of information
distribution and control, as well as for developing state standards for
licensing. The Ministry of Health Protection regulates certain issues
regarding the location of the telecommunications equipment.
Licensing
The Law determines the licensing requirements applicable to
companies providing communication services and gives a detailed list of
circumstances when a licence can be suspended or revoked. The list of
telecommunication services that are included in the licences and
relevant licensing requirements is yet to be established by the Russian
Government. When established, this list will be reviewed by the
Government annually.
A licence will be issued by the Ministry of Communications and
Information Science for a period up to 25 years with a possibility of
extension. The list of documents and fees necessary to obtain a licence
is provided in the Law and includes:
an application letter (standard form);
the constitutional documents of the applicant;
the certificate of state registration of the applicant;
a description of the communication services with relevant technical
data;
a document confirming the payment of the application fee.
The Law provides for specific cases when a licence for performing
communication services will be granted via a tender, such as:
if the State Radio Frequencies Commission establishes that there are
limited number of available frequencies in a particular territory; and
167
if the Ministry of Communications establishes that the capacity of

communication networks in the territory is limited, thus the
number of telecommunication operators in this territory should be
limited.
The new requirements are designed to stimulate competition among
telephone operators.
Telecommunication equipment
The Law contains a requirement that most telecommunication
equipment, either manufactured in Russia or imported, must be
certified. A list of specific equipment subject to mandatory certification
is yet to be established by the Russian Government. The certification is
performed by accredited certification institutions. The Russian
Government has not yet established the procedure for the accreditation of these institutions.
The Law also provides that some telecommunication equipment is
not subject to mandatory certification, and voluntary certification
conducted by a manufacturer itself will suffice (if confirmed by a declaration of compliance). This is a new provision for Russian legislation
regulating telecommunication operations, which is expected to
encourage the development of the telecommunications market in the
Russian Federation.
3.8

Vyacheslav Masenkov, Deputy GeneralDirector and Alexander Chachava,
Senior IT Analyst, RBC
The Russian IT market developed at a faster pace compared to the

world IT market in the 1990s, gradually decreasing the gap between
the levels of their development. Amid a recession in Western countries
in 2000 to 2001, the Russian market was booming after the financial
crisis of 1998 it added 40 to 50 per cent annually. As a result, the
Russian IT market emerged and reached a volume of $4.7 billion by
2002.
Table 3.8.1 The IT market volume in billion dollars and the shares
of regions
The markets
volume in
2002
The USA
Europe*
Japan
4 tigers**
Russia
The rest of
the world
Total
305
408
120
24
4.7
126.3
988
2001 %
2002 %
2003 %
30.3
42.7
11.9
2.4
0.41
12.29
30.9
41.3
12.1
2.5
0.47
12.73
30.6
40.0
12.3
2.6
0.52
13.98
100.0
100.0
100.0
*Europe without Russia and the CIS

**4 tigers Hong Kong, South Korea, Singapore, Taiwan
Source: EITO 2003 data
According to estimations of the RBCs department of consulting,

growth in the IT market, including the grey market, amounted to
169
about 17 per cent in 2003. Our achievements are especially impressive

amidst the gloomy situation on the world IT market. According to
information from the US consulting company IDC, the year 2002 was
the worst year in the history of development for the world IT sector.
Table 3.8.2 The ratio of the IT market and the GDP of different
countries
Country
Russia
The USA
Germany
France
Italy
Spain
Poland
The Czech Republic
Estonia
The UK
The IT market in 2002,

$ billion
The share of GDP,

%
4.7
310
75
58
28
13
3.3
1.9
0.19
71
1.2
6.38
3.65
3.99
2.45
2.3
2.1
3.8
3.7
5.17
Source: EITO
Robert Farish, the IDC regional director for Russia, Ukraine and
Central Asia, said that Russia continued to be one of the few dynamically developing markets in the whole world in 2003. According to IDC
estimations, the total volume of the Russian IT market was $4.92
billion in 2002, and by 2007 it is forecasted to reach $10.31 billion. The
markets dynamics over the past few years have also been high. In 2002
the market added 18.4 per cent, while in 2003 its advance was 22.7 per
cent to $6.04 billion, according to preliminary estimations. According to
Robert Farish, the highest growth was performed by such segments of
the market as services (system integration) with a 23.4 per cent gain
and software (47.2 per cent). At the same time the market retained its
technical orientation, since the share of expenses on services and
software in the structure of total expenses on information technologies
was just 37.6 per cent in 2003.
Services and software will keep growing at a higher pace than the
whole IT market. The share of services and software is expected to be
up to 50 per cent of the IT market by 2007.
The market of custom programming amounted to about $300
million in 2003 (according to estimations of the RBC department of
consulting). The markets advance against 2002 was 30 per cent. The
forecast for 2007 is about $800 million, amid annual growth of about 25
to 30 per cent.
170
Market Potential
Table 3.8.3 Services, software and custom programming
Services in the sphere of

system integration
Standard software
Custom programming
2001,
$ bln
2002,
$ bln
2003E,
$ bln
0.7
0.34
0.17
0.84
0.43
0.23
1.01
0.58
0.3
Growth
in %
20
36
30
Source: estimations of the RBCs consulting department
On the whole, Russia looks excellent against a gloomy background.

However, one should realize that growth on the domestic IT market is
also due to the fact that it has room for development. Specialists say that
even with the current pace of growth, Russia will need more than 100
years to reach the volume of the IT market of the USA registered in 2002.
The largest investor that provided the lions share of the demand for
IT was the State: expenditure of state agencies on electronic communication development amounted to almost $3 billion in the period from
2001 to 2003. This expenditure is expected to be about $5 billion in the
period from 2004 to 2007. The government will spend this money on
providing state agencies with access to the Internet, computers, office
appliances and necessary software. In particular, the expected IT
budget of the Russian Tax Ministry is about $600 million for the next
four years, including $150 million that was attracted as a credit from
the World Bank in 2002. Another $150 million were allocated by the
World Bank at the end of 2003.
Tens of millions of dollars per year are invested in IT by the Russian
State Customs Committee and the Federal Treasury. Total computerization has started in the Pension Fund. About $23 million were spent
on IT by branches of the Pension Fund in large regions and $10 million
in Moscow in 2002. The recent census also contributed to the revenues
of developers. The Russian State Statistics Committee spent about $25
million on IT within the framework of the census.
However, the most global project in the IT field is undoubtedly the
Electronic Russia programme (which as was suggested would give a
totally new incentive to the development of the IT market). Despite the
fact that the government allocates much less resources for global
informatization than was initially planned, the growth dynamics still
inspires optimism. For example, in 2003 expenditures of the federal
budget for Electronic Russia more than doubled and reached R1.43
billion ($44.5 million) compared to R600 million ($20 million) in 2002.
To sum up, it is worth mentioning another significant event that
happened almost without the influence and will of the government.
This concerns Internet trade. In 2002, the volume of retail via the
171
Internet doubled in Russia. According to the Brunswick UBS Warburg

investment company, the assumed turnover of all Russian Internet
stores reached $240260 million in 2002 against some $100 million in
2001. Brunswick UBS Warburg forecasted another more considerable
jump in 2003. According to expert estimates, this year Internet vendors
will have sold goods worth $650 million.
Table 3.8.4 The structure of Russias IT market
PC
Spare parts and peripherals
System integration services
Software development
Custom programming
Electronic commerce
Total
2001,
$ bln
2002,
$ bln
2003E,
$ bln
Growth
in %
1.55
1.15
0.7
0.34
0.17
0.2
4.11
1.7
1.34
0.84
0.43
0.23
0.27
4.81
1.86
1.56
1.01
0.54
0.3
0.36
5.63
10
17
20
26
30
35
17
Source: estimate of RBCs department of consulting
Despite the industrys obvious success, the very structure of the

Russian IT market is rather primitive, as yet, compared to that of
Western European countries. While the IT market in Western Europe
is several times larger than the telecommunications market, in Russia
it is almost half the size. While in Western Europe the share of
equipment is some 30 to 50 per cent, depending on the country, in
Russia this figure is 63 per cent. Apparently, our country is completing
the first stage of informatization that envisages basic equipping of
workplaces with computers, their integration into networks and
connection to the Internet, and the purchasing of PCs by home users.
The next stage we are to go through is the transition to a higher
technological level where not hardware but software solutions, services
and electronic commerce are visible to the naked eye. It is worth
pointing out that as compared to 2001, Russia has made several steps
towards this. For instance, the share of computers, spare parts and
peripherals declined in total sales volume (grey imports taken into
account) from 66 per cent ($2.7 billion) to 63 per cent of all resources
spent on the IT market ($2.96 billion), while revenues from software
development went up from 12 per cent ($500 million) to 13 per cent
($630 million).
While in the West the software market gained only 0.8 per cent, it is
accelerating in Russia. As for the market growth rate, the majority of
analysts agree on a rather high figure of 25 per cent (this is the data
cited by IDC).
R-Style
Lanit (8)
Verysell
TechnoServ
A/S
Rosco
OCS
5
6
Distribution of
computer
equipment
Distribution of
computer
equipment
A group of
companies (5)
Distribution of
computer
equipment
A group of
companies (6)
A group of
companies (2)
A group of
companies (3)
Integration
A group of
companies (4)
Integration
The field of
activities
Source: CNews, RBCs department of consulting
10
Aquarius
Rover / Bely
Veter
IBS
LC Group (1)
Name
No.
Moscow
Moscow
Moscow
Moscow
Moscow
Moscow
Moscow
Moscow
Moscow
Moscow
City
4,284,749
4,608,450
4,702,500
5,135,130
5,788,724
5,172,750
6,865,650
8,151,000
8,621,250
10,972,500
2002
Turnover,
thsds of
roubles
Table 3.8.5 The largest participants on the IT market
2,371,946
2,801,280
4,960,600
4,397,426
4,202,950
3,209,800
5,789,312
6,682,220
6,653,040
7,295,000
2001
Turnover,
thsds of
roubles
80.64
64.51
5.20
16.78
37.73
61
19
21.98
29.58
50
Growth,
%
318
300
120
485
1,500
300
647
2,000
1,200
900
No of
employees
13,474
15,362
39,188
10,588
3,859
17,243
10,612
4,076
7,184
12,192
Production
per capita
172
Market Potential
173
Meanwhile, among the top ten of the Russian IT market in the first
national rating compiled by CNews.ru and RBCs department of
consulting, there are no companies that are involved in software development only or project integration only, and these are the enterprises
in todays Russia that are the most highly technological in the industry.
As for forecasts, in the opinion of the Telecommunications Ministry
and IDC, the markets growth rate will be preserved in general but IT
services will gradually replace the volume of hardware supplies.
According to the forecast of RBCs department of consulting, in 2003
growth will continue and reach 12 to 18 per cent. At the same time, the
software, electronic commerce and IT consulting market will demonstrate the most dynamic growth.
3.9

Alexander Raifeld and Andrei Kouzmin,
Deloitte & Touche
Introduction
According to industry experts, the number of motor vehicles in Russia
has increased by approximately 50 per cent over the last five years,
reaching 22 million passenger cars, 540,000 buses and 3.5 million
heavy trucks in 2003. This translates into car ownership of 148 cars per
1,000 people, significantly lower than in emerging markets with
comparable per capita GDP levels. In the period 19982003, domestic
passenger vehicle output grew in line with GDP, but sales rose much
faster due to second-hand imports. Car prices in Russia are still relatively low, and most consumers are highly price sensitive.
The Russian automotive market is also characterized by a significant proportion of obsolete vehicles. Statistics show that 50 per cent of
all cars in Russia are 1015 years old. These figures suggest that a
significant latent replacement demand exists, which is likely to materialize as disposable incomes grow. Industry analysts believe that the
main beneficiaries of this trend in the medium term will be domestic
producers, as they are able to offer low prices for their products.
Analysts predict car ownership to continue rising at a rate of 45 per
cent per annum until 2005, due to the growth of disposable incomes,
the increased availability of bank auto loans, and protectionist
government policy.
In July 2002, the Russian Government approved The Concept for
Automotive Industry Development, an eight-year programme
designed to upgrade the Russian car sector. The Governments
objective is to encourage foreign car-makers to set up domestic
production facilities during the transitional period, and give domestic
producers time to focus on improving the quality and design of their
automobiles. Meanwhile, tariffs on new car imports will go up and stay
at an increased level for five years. Only in 2010 will tariffs be reduced
again, in compliance with the requirements of the WTO.
175
While relatively slow in breaking from its centrally-planned past,

the vast majority of Russian automotive manufacturers have now been
privatized. These companies have begun to benefit from an expanding
middle class, better internal management and protectionist policies.
They are also becoming the main acquisition targets of domestic
Financial Industrial Groups (FIGs) and metal production companies.
We see these trends continuing and accelerating as the Russian
economy continues its expansion.
Soviet manufacturing had virtually 100 per cent vertical integration
due to central planning, and the Russian automotive sector continues
that trend. Major original equipment manufacturers (OEMs) often
achieve over 80 per cent internal content, which is significantly higher
than their Western European and North American counterparts.
Domestic OEMs currently refrain from importing major components,
as it would make their final production costs unaffordable for most
consumers.
Western car manufacturers are interested in producing cars in
Russia due to a large, unsatisfied demand, the availability of an inexpensive labour force, a vast resource base and the geographical location
of the country. However it is unlikely that the world auto giants would
purchase any domestically manufactured cars, due to the notorious
reputation for poor quality and outdated production standards.
Russian automobile producers have so far not been able to take
advantage of existing protecting import tariffs, or to bring the quality
level of their products up to Western standards. We believe that world
auto leaders would prefer to move to Russia by constructing their own
assembly plants and gradually expanding the number and the
complexity of tasks performed in their production facilities. This is
currently being done by Ford Motor Company, Kia and BMW; these
automobile manufacturers have already opened plants in Russia. We
expect a few other companies to move to Russia in the short- to
medium-term future.
The domestic automotive sector is dominated by three large OEMs:
Volgski Automobile Plant (AvtoVAZ), Gorky Automobile Plant (GAZ)
and Ural Automobile Plant (UAZ). KaMAZ dominates the heavy truck
sector while Pavlov Autobus Plant (PAZ) is the leading manufacturer of
buses. Recent production statistics reported by the State Statistics
Committee show that in the most lucrative sector, personal automobiles, AvtoVAZ heavily dominates the market. As Russias largest car
producer, it accounted for 75 per cent of domestic cars, leaving its two
main competitors, GAZ and UAZ, far behind. Its new joint venture with
General Motors, which started production of the Chevrolet-Niva in
September 2002, will further solidify AvtoVAZs position among traditional domestic producers.
176
Market Potential
The Russian big three

AvtoVAZ
The personal car market is dominated by the Volgski Automobile Plant
(AvtoVAZ) with its popular and virtually omnipresent Lada brand name.
The history of AvtoVAZ dates back some 30 years to when it was
developed with Fiat. The plant was built as a high volume manufacturer
of passenger cars, and is constantly expanding its production capacity.
Lada cars are deeply inferior both in terms of quality and design. The
company does not use existing tariff barriers as an opportunity to work
on improving its automobiles and bringing them up to world standards.
As a result, Lada continues to lose its position on the local market and
suffers from a poor reputation. We believe that AvtoVAZs market share
will continue to diminish, especially once import tariffs are lifted in
compliance with WTO requirements. According to AvtoVAZs CEO and
news agencies, in 2003 the company manufactured a total of over
800,000 vehicles and generated a net profit of 5 billion roubles, which is
a dramatic increase from 700 million roubles in 2002.
In February 2004, AvtoVaz signed a 3-year 240 million dollar loan
from Deutsche Bank. Although the company has not yet announced its
plans, we believe the funding will go to upgrading, improving and
updating the companys current product line. Although we view this
loan as a very positive step not only for AvtoVAZ but also for the automotive industry as a whole, we do not believe that it will radically
change AvtoVAZs situation. Major Lada problems are likely to remain,
discouraging consumers from purchasing VAZ vehicles.
GAZ
GAZ is Russias second-largest automotive producer, producing large
passenger cars, light and medium trucks, and minibuses. Despite new
management, the company continues to suffer from poor sales of its
flagship business-class automobile Volga, characterized by poor quality
and an out-of-date Soviet era design.
GAZ however is very successful (more than 55 per cent of domestic
output) in the light commercial vehicle (LCV) sector, which it dominates with the Gazelle. The automobile has a load capacity of 1.35
tonnes and 9 cubic metres of cargo space. Lack of competition and low
costs have made it a bestseller with Russian enterprises and
entrepreneurs. Overall the company was able to increase its
production by 4.3 per cent to 213,000 automobiles in 2003.
UAZ
While UAZ is by far the smallest of the Big Three, it is the most
Western-oriented company. Despite the companys strong production
Automotive Industry
177
growth of approximately 16 per cent in 2003 its market position

remains vulnerable, as most of its products have not benefited from
investments in design enhancements. UAZ produced almost 33,000
vehicles in 2003. Mainly a producer of LCVs and minivans, the 3,160
and 3,162 sport utility vehicles may provide the impetus it needs to
become a stronger competitor. Severstal, a metallurgical giant, owns a
controlling stake in UAZ. New strategic investors, experienced
management, imported Swiss and German equipment, and a relatively
good corporate structure make UAZ a potentially successful company
on the domestic market.
Recent trends
There are two significant trends currently affecting the auto manufacturing industry in Russia; the shift from screw-driver assembly to full
local production of foreign industry giants, and the continuing loss of
market shares by major Russian car manufacturers. The first trend
creates a strong positive impact not just on the automotive sector but
on the whole economy as well. Foreign automobile manufacturers
bring in the knowledge, technology, skills and investment necessary to
produce high quality cars in Russia. World automobile giants will be
the major driving force of the automotive sector expansion as more and
more foreign companies decide to open their production facilities in
Russia.
On the other hand the market share in the passenger car segment of
traditional domestic car manufactures will continue to shrink. Both
AvtoVAZ and GAZ were unable to offer a product of quality and design
comparable to those of Western companies. Their most important
advantage low price will diminish in importance as national welfare
continues to increase. Russian manufactures will need to make major
investments in R&D in order to create competitive passenger vehicles.
These investments, however, seem unlikely at present.
Major FDI projects

General Motors joint venture with AvtoVAZ is the largest project of
this kind. GM, AvtoVAZ and the European Bank of Reconstruction and
Development (ERRD) signed a general agreement setting up a joint
venture in June 2001. Under the deal, AvtoVAZ provides the facilities,
equipment and expertise while GM mainly contributes cash and some
equipment. GM and AvtoVAZ each receive a 41.5 per cent stake worth
$99.1 million each, while EBRD owns the remaining 17 per cent of
stock, worth $40 million. The bank provides an additional $90 million
in loans. The joint venture started production of the Chevrolet-Niva
178
Market Potential
AWD vehicle in September 2002 and is planning to increase its present

output capacity. However, GM withdrew its plans to start Opel Astra
production at this plant in 2005.
The Ford Motor Company opened a $150 million assembly plant in
Vsevolozhsk near St. Petersburg in July 2002 and started the production
of Ford Focus cars. The company reduced the original price it charged in
Russia for its European-produced Ford Focus by almost 21 per cent,
creating a strong competitive advantage by offering its consumers an
attractive price-quality combination. As a result, demand for the Ford
Focus model produced in Russia (which retails for $11,400 and is
available on credit) exceeds supply to such a degree that consumers have
to wait up to 34 months before getting their cars, having made a down
payment or paid full price for them. Currently the number of unfulfilled
orders for the Ford Focus produced in Vsevolzhsk stands at 9,000.
Avtotor currently owns assembly factories for BMW and Kia automobiles in Russia. The company is constantly expanding the range and
complexity of tasks it performs. The company invested approximately
$100 million in BMW production facilities and is currently able to
reach an output of 15,000 cars annually. Avtotor can serve as a good
example for the future of the Russian automotive industry, where
foreign luxury and economy brands being produced in Russia will play
a major role.
Consolidation
Consolidation has begun in the industry driven by cash-rich investors,
hungry to invest the profits from their primary businesses or create
profitable alliances. Siberian Aluminum (SibAl) has been the most
active, acquiring a controlling stake in PAZ and a blocking stake (over
25 per cent) in GAZ. It reportedly owns controlling stakes in Likinsky
Autobus Plant (LiAZ) and several component suppliers to the industry,
focusing mainly on high-value components such as engines. Severstal,
another metals giant, has acquired a controlling stake in UAZ. In
almost all instances the new owners took immediate action to
restructure the acquired companies by reducing debts, improving
procurement and distribution, and eliminating barter schemes. We
view such consolidation as a positive step for automobile manufacturers, as they can benefit from additional financial resources and
experienced management.
Conclusion
According to industry specialists and our estimates, a demand for lowprice (under $6,000) automobiles will remain, which will be fully met
Automotive Industry
179
by domestic producers. However, as disposable incomes of consumers

grow, peoples preferences will shift towards better quality and better
designed foreign car manufacturers. Another significant recent trend
in the automotive market is the fast development of auto loans.
According to recent data, by September of 2003 Russian banks gave out
car loans for a total of 2 billion dollars. This number is projected to
grow at a high speed given the fact that most Russian banks currently
develop their loan programmes and that consumers are more willing to
borrow money from a bank. While the development of auto loans is
likely to boost sales in all segments of the car market, we expect the
major impact to take place in a segment of foreign inexpensive midsized cars with a price tag of $15,000$20,000. Domestic car makers
would not be able to benefit fully from this market trend as their
products are not competitive against foreign auto giants. Thus, we are
sceptical about how domestic auto producers would be able to withstand tough competition from international giants.
Our somewhat pessimistic approach towards traditional domestic
car manufacturers has recently been echoed by Arkady Dvorkovich,
Deputy Head of the Ministry of Economic Development, who did not
mention the automotive industry as a growth industry. Moreover, he
called it the most risky industry. This falls in line with our opinion, as
we see the greatest potential for growth in the automotive sector
coming from Russia-based production of foreign manufacturers. This is
especially true as Renault, Toyota and other giants are seriously
considering launching their factories in Russia.
3.10
The Pharmaceuticals
Market
Anton Timergaliev, Senior Market Analyst,
RMBC
Market size
The Russian pharmaceutical market has now passed the serious
breakdown period following the financial crisis of 1998 and, since 2000,
has experienced steady growth. As the income of the population
increases, this growth shows no signs of weakening (see Figure 3.10.1).
While the 16 per cent growth of 2002 was mainly due to the 10 per cent
VAT imposed since January 2002, and actual growth of the market in
pre-VAT prices was about 6 per cent, the growth rate of 2003 accounted
for 17 per cent1 in actual prices or over 9 per cent in fixed prices. The
5
Market value, $ Bln
4
3.5
9%
3.2
2.9
3
2.5
3.7
9.30%
2.5
5.90%
10%
5%
7.00%
0%
-5%
1.5
-10%
1
0.5
15%
-15%
-14.20%
GDP per capita, annual increase, %
20%
4.4
4.5
Market value,
consumer prices
GDP per capita,

annual increase
-20%
1999
2000
2001
2002
2003
Source: Goskomstat, RMBC
Figure 3.10.1 The Russian pharmaceutical market values ($ billion)

1
Market growth in actual US$ prices accounted for 19 per cent, but this figure was
affected by the dynamics of the exchange rate R/$ in 2003. The nominal average
exchange rate rise was about 2 per cent, thus the market value growth (ie in rouble
prices) accounts for about 17 per cent.
The Pharmaceuticals Market
181
average annual consumption of drugs increased from $17 per capita in

1999 to $26 in 2002, and $30 in 2003. These figures are the result of the
significant upturn of the Russian economy and ensuing growth of the
income of the population. But, since the income growth resulted from
favourable external conditions, some slowdown in market growth is
expected for the next few years. According to our forecasts, during the
next three years the Russian pharmaceuticals market will be
increasing at annual rate of 78 per cent (in fixed prices), and in 2006
its value will total $5.5 billion in final consumer prices. This estimate is
based on the assumption that the Russian political system will remain
stable and that no major changes take place in the Russian legislature.
Market structure
In 2003, sales of pharmaceuticals to pharmacies accounted for about 80
per cent of the total sales in the market, over 15 per cent were for
hospital purchases, and federal state procurements accounted for
about 5 per cent. The retail sector is dominated by Rx (prescribed)
drugs, which account for about 62 per cent of the retail sales (see
Figure 3.10.2). Sales to pharmacies have a tendency to increase in the
autumn/winter season, a cough and cold period, and have a stable
minimum in the summer months (see Figure 3.10.3).
Sales of the Russian pharmaceutical market are concentrated in
Russias major economical and populated regions. In 2003, the cumulative share of the top 10 regions by retail sales value accounted for
about 41 per cent of the market, with over half of this figure being
accounted for by Moscow and St Petersburg. The population of these two
cities together accounts for about 10 per cent of the countrys total,
Prescribed drugs
62%
OTC drugs
38%
Source: RMBC
Figure 3.10.2 Structure of the retail sector of the pharmaceutical

market in 2003, consumer prices
182
Market Potential
$ 3.5 Bln
$ 2.9 Bln
$ 2.5 Bln
800
1000
Retail sales value, $ Min
1200
600
400
200
0
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
2001 2001 2001 2001 2002 2002 2002 2002 2003 2003 2003 2003
Source: RMBC
Figure 3.10.3 Pharmacy sales of drugs, quarterly dynamics

while in the retail sales of drugs in 2003 Moscow and St Petersburg
accounted for 17 and 4.2 per cent of the total, respectively (see Figure
3.10.4). This cumulative share in 2000 accounted for 19.9 per cent of the
retail sales, and has been slightly increasing since then at annual rate
of 0.5 per cent points, which illustrates the trend of the populations
income becoming centralized.
Pharmaceutical supply
The pharmaceutical market in Russia is dominated by imports. In unit
terms the cumulative share of domestically-manufactured drugs for
Other regions
68%
Krasnodar region
2%
Samara region
Sverdlovsk region
2%
3%
Moscow
17%
St. Petersburg
4%
Moscow region
4%
Source: RMBC
Figure 3.10.4 Pharmacy sales of pharmaceuticals by regions in 2003,

retail prices
183
the retail and hospital sectors accounted for over 75 per cent in 2003,
but in monetary terms its value was below 30 per cent of the market.
This means that the average per-package price for imported drugs is
much higher then the average price for domestic drugs. During the last
three years the cumulative share of imported drugs in retail sales was
almost the same and accounted for 7273 per cent in value terms. In
2002 it decreased slightly due to the price increase after VAT introduction, but in 2003 the growth of the domestic drugs total sales value
was slower than for the imported ones, and thus the share of the
domestic drugs accounted for 27 per cent, the same as in 2001 (see
Figure 3.10.5).
Imported drugs
Domestic drugs
Share in the total sales value, retail prices, %
100%
90%
80%
70%
69%
73%
72%
73%
+11%
+16%
+20%
27%
28%
27%
-5%
+22%
+14%
2001
2002
2003
60%
50%
40%
30%
31%
20%
10%
0%
2000
Source: RMBC
Figure 3.10.5 Retails sales of foreign and domestically-manufactured

drugs, shares in the total retail sales and annual increase
Annual imports of pharmaceuticals in Russia have been increasing
rapidly since 2000 and totalled $2.12 billion in 2003 (see Figure
3.10.6). The announcement of VAT introduction strongly stimulated
imports at the end of 2001. This led to an enormous increase of imports
that year, followed by a subsequent recession due to the over-stock
effect. This explains the recession of the imports values in 2002 and
rapid growth in 2003.
184
Market Potential
Import value, $ Bln
2.50
2.00
2.12
1.81
1.50
1.00
1.56
1.26
1.23
0.82
0.50
-35%
+49%
+47%
-14%
+36%
1999
2000
2001
2002
2003
0.00
1998
Source: State Customs Committee
Figure 3.10.6 Imports of pharmaceuticals in Russia

The main importers of drugs into Russia are Western countries, and in
2003 the cumulative share of Western Europe, USA, Canada and Japan
accounted for 66 per cent of total pharmacy sales and hospital
purchases of imported drugs, by value. This is 1 per cent rise over the
2002 figure. The share of Eastern Europe manufacturers accounted for
24 per cent of imported drug sales. Indian manufacturers have about 7
per cent of the market.
The list of the top 10 manufacturers by retail sales and hospital
purchases in 2003 includes only foreign companies. The only domestic
manufacturer present in 2002 (which includes five pharmaceutical
factories that previously belonged to ICN Pharmaceuticals Inc. and
were sold in 2003 to a domestic investment company, Profit House) left
the top 10 in 2003 (see Figure 3.10.7). The list of the leading producers
is relatively stable: apart from the ex-ICN factories, the only company
that has left the top 10 in 2003 is Servier Pharmaceuticals. The two
new entrants to the list are Nycomed and Lek D.D., which rose from
11th and 14th positions respectively. Apart from these, two other
companies had significant sales increases in 20022003 sales of
Pfizer International Inc. grew by 30 per cent, and sales of BerlinChemie/Menariny Pharma G.m.b.H. grew by 43 per cent.
Domestic manufacture of drugs in Russia in 2003 just reached the
pre-1998 crisis level. After a 38 per cent increase recorded in 2000,
growth almost stopped during 20012002, and only in 2003 did it nearly
reach the total market growth figure (see Figure 3.10.8). The list of the
leading manufacturers by value in 2003 has not changed since 2002 (see
Figure 3.10.9). The shares of most of the leaders slightly increased (the
exceptions are Bryntsalov-A, Biosintez, Biohimik); thus, the total share
of the top 10 companies accounted for 52 per cent of the total domestic
production value, compared to 51 per cent in 2002.
185
Others
73.9%
Lek D.D.
2.1%
Aventis Pharma
4.0%
Nycomed
2.2%
Gedeon Richter Ltd.

3.2%
KRKA D.D.
2.2%
Pfizer International Inc.*

GlaxoSmithKline
2.7%
2.2%
Novartis
Berlin-Chemie /
2.3% Sanofi-Synthelabo
Menarini Pharma
2.6%
G.m.b.H.
2.7%
* including Pharmacia N.V./S.A.
Source: RMBC
Figure 3.10.7 Top 10 drug manufacturers by retail sales and hospital

purchases value in 2003, wholesale prices
It should be mentioned that by 2005 all pharmaceutical manufacturers

in Russia must pass certification under the GMP international standards. Today most of Russias current pharmaceuticals production facilities employ obsolete equipment and experts estimate that the
transition to the GMP standards for the entire Russian pharmaceuticals industry will need some $2 billion worth of new investment. As a
result, most of the drugs manufactured in Russia are of a quality
Manufacture value, $ Mln
1200
1000
800
1099
600
910.4
916.1
925
-35%
+38%
+0.6%
+1%
+19%
1999
2000
2001
2002
2003
1019
400
658
200
0
1998
Source: Goskomstat (RMBC analysis)
Figure 3.10.8 Domestic production of pharmaceuticals in Russia
186
Market Potential
Others
48%
Biohimik
3%
ICN Pharmaceuticals Russia
10%
Biosintez
3%
Sintez
4%
Moskhimpharmpreparaty
4%
Akrikhin
4% Bryntsalov A
4%
Nyzhpharm
5%
Otechestvennye
Lekarstva
Veropharm
10%
5%
Source: Goskomstat (RMBC analysis)
Figure 3.10.9 Top 10 manufacturers of pharmaceuticals in Russia by

production values in 2003
suitable for domestic use only, or for exports to other post-Soviet

republics and developing countries. At present only a few companies,
about 1 per cent out of a total of 800 pharmaceutical manufacturers,
will be able to meet GMP by 2005, and because of this there is the possibility that the GPM transition terms could be changed. On the other
hand, these companies are mostly the market leaders and several of
them form the active lobby (ARMP),2 which supports the introduction of
the GMP standards in 2005. Thus, the future of the domestic sector of
the Russian pharmaceutical market is still very uncertain.
Wholesale distribution of pharmaceuticals

Among the approximately 4,500 pharmaceutical distributors operating in Russia, most operate in their own regions. The largest national
distributors are Protek Co., SIA International and Shreya Corporation.
According to experts, their cumulative share of the market is estimated
at about 50 per cent. In 2003, among the leading distributors a new
national player, ROSTA, appeared (as a result of merger of Farm
Tamda 77, Rossibfarmacia and Artromed). The share of these four
leaders in total pharmaceutical imports in 2003 accounted for 17.4 per
cent, 13.5 per cent, 6.1 per cent and 2.6 per cent respectively.
2
Association of Russian Pharmaceutical Manufacturers, which includes such leading

domestic companies as Veropharm, Pharmsintez, Nyzhpharm, Ufa-Vita, Otechestvennye
Lekarstva, Akrikhin.
187
It should be noted, that today there is a tendency for the creation of

vertically-integrated structures. As a part of this, the leading distributors also try to develop related sectors: pharmaceutical production
and the retail sector. Thus, Protek has developed its own manufacturing company, Sotex, and the pharmacy chain in Moscow called
Rigla, while another leader, SIA International, has announced its plans
to manufacture drugs.
Retail sector
The pharmacy business in Russia includes about 65,000 retail outlets.
The share of pharmacies accounts for about 30 per cent of total number
of retail outlets, while the smaller drug outlets share is 70 per cent.
About 65 per cent of the pharmacies and 62 per cent of the smaller
outlets are state or municipal owned.
According to experts, the main tendency in the pharmacy market is
an aggressive growth of networks, especially in the private sector. This
process of agglomeration of drugstores into pharmacy networks has
been very noticeable during the last few years. In addition, since 2003
there has been an expansion of the large pharmacy networks (such as
Rigla, 366) into regions. According to experts, the share of these
networks today is estimated at 40 per cent of the pharmacy market.
Sales structure
The structure of retail sales by therapeutic groups for the last two
years was quite stable: in 2003, changes of shares of ATC groups by
first level codes in retail sales did not exceed 0.7 per cent compared to
2002 figures (the top selling therapeutic groups are shown in Figure
3.10.10). The most significant changes in sales structure were the
growth of the drugs for treatment of the respiratory system (+0.7 p.p.)
and the decrease in the group of medicines for the nervous system (by
0.6 p.p.). The analysis of the retail sales by second level ATC codes
groups shows that in 2003 there were no significant changes compared
to the corresponding period of previous year (see Table 3.10.1).
The structure of hospital purchases (see Figure 3.10.11) by therapeutic group in 2003 changed more significantly compared to the year
2002. The largest changes were a 2.5 per cent point decrease of the
cytostatics & immune modulators and 1.7 per cent point increase of the
anti-microbics share.
188
Market Potential
Other groups
29%
J, Antimicrobic for
system use
9%
R, Medicines for
treatment of
respiratory system
diseases
12%
C, Cardiovasular
medicines
14%
A, Digestive
medicines and
albumen rotation
21%
N, Medicine for
treatment of nervous
system diseases
15%
Source: RMBC
Figure 3.10.10 Top 5 ATC groups by retail sales in 2003, retail prices
Table 3.10.1 Top 10 therapeutic groups by retail sales in 2003
Rank
2003
2002 Code ATC group
J01
2
3
4
2
3
4
N02
A11
C09
5
6
7
8
5
6
9
11
N06
R05
G03
M01
9
8
C01
10
7
N05
Total top 10
Antibacterials for systemic

use
Analgesics
Vitamins
Agents acting on the
renin-angiotensin system
Psychoanaleptics
Cough and cold preparations
Sex hormones
Anti-inflammatory and
anti-rheumatic products
Cardiac Therapy
Psycholeptics
Sales value,
in pharmacy
purchasing
prices,
$Mln
Share in
pharmacy
sales, %
2003
2002
2003
2002
186.7
174.1
141.1
170.8
148.4
116.8
6.9
6.4
5.2
7.4
6.5
5.1
108.5
99.9
95.3
78.4
87.4
84.1
66.8
58.4
4.0
3.7
3.5
2.9
3.8
3.7
2.9
2.5
73.8
72.7
68.1
1098.6
55.5
63.5
65.8
917.5
2.7
2.7
2.5
40.5
2.4
2.8
2.9
40.0

L, Anti-tumour
medicines and
immunemodulators
10%
A, Digestive
medicines and
albumen rotation
11%
189
Other groups
23%
J, Antimicrobic for
system use
28%
N, Medicines for
treatment of nervous
system diseases
12%
B, Medicines influence
on blood and bloodproduction system
16%
Source: RMBC
Figure 3.10.11 Top 5 ATC groups by hospital purchase value in 2003,

wholesale prices
3.11
Investing in Russian
Pharmaceuticals: Crisis
or Renaissance?
Denis Matafonov, Analyst, Antanta Capital
The Russian pharmaceutical sector remains a minefield for the

investor. Purchasing shares in pharmaceutical companies today is
considered high risk and we believe that the shares growth potential of
the majority of trading companies does not make up for the risk of
investments into the sector.
The overall industry and development trends

We believe that industry growth in 2003 may reach 1215 per cent if
the situation in the pharmaceutical sector does not worsen. In 2003,
Russian producers will be placed into two categories: those investing in
restructuring their production and in the production of new medicines,
and those disregarding the problems in the industry. The latter
category of producers are most likely to start dumping their products
onto the market and might complicate the situation for leading generic
companies. Only the best companies will be able to compete successfully with importers.
Currently there are at least 150 large, and a significant number of
smaller, producers of finished medicaments in the pharmaceutical
market. Their overall annual production has been fluctuating in the
range of $850$900 million over recent years.
How the Russian pharmaceutical sector lost its plants

To better understand the current situation in the sector it is necessary
to mention a few very important assumptions upon which its development is based. In Soviet times, Russia produced only the raw ingredients (substances) for medicines. The drugs themselves were
Investing in Russian Pharmaceuticals: Crisis or Renaissance?
191
prepared on the basis of these substances in production plants in

Poland, Hungary, GDR and Czechoslovakia. This division of labour
seemed appropriate, as the development of new substances (and the
production of already existing ones) is, in fact, the most complex and
highly-technological stage of the production process. The growth of the
pharmaceutical sector was very dynamic: average production growth
was over 7 per cent during the period of 19801991, which was significantly higher than GDP growth. However, the pharmaceutical boom
was inevitable considering the level of highly-qualified manpower in
the USSR, close integration with other sectors, a high technological
level of production and significant investments into science and technology. The medicines produced were in compliance with all the international standards. The volume of substances produced was enough to
supply both Russian plants and those in the member countries of the
Council for Economic Mutual Assistance.
Unfortunately, the discrepancy in the structure of the production
capacity, having been the main advantage of the existing specialization, turned out to have a negative impact on the sector during the
mid-1990s, when the pattern of economic development in Russia
changed. A significant number of facilities of substances production
went out of operation due to lack of timely investment. As a result,
Russia transformed from the largest producer into a consumer of
substances within the period of a decade. Therefore, pharmaceutical
companies in Russia have only one choice today to build their own
plants producing finished medicines on the basis of imported
substances and participate in a highly-competitive market with
importers, whose current share of producers of finished medicines in
Russian is over 82 per cent.
Importers are winning the battle for the market share

Since the beginning of the 1990s, the number of imported goods in
Russia has increased dramatically these goods range from
substances to finished medicines. These imported goods are better
than the Russian products in quality and often in price.
The structure of imports has also undergone change. In 1999 almost
half of Russias imported medicines came from India, but in 2000 the
share of medicines imported from developed counties increased dramatically, and currently stands at about 60 per cent. The flow of imported
medicines that flooded the Russian market almost put Russian
producers on the verge of extinction. Russian companies have lost the
battle for the pharmaceutical market. In 1999, their share of the market
was 60 per cent, while in 2002 their share fell to only 20 per cent.
The reduction in sales volumes of Russian medicines is connected
first with the reduction in production volumes. While the volumes in
192
Market Potential
70%
60%
58%
57%
50%
40%
30%
30%
20%
20%
10%
0%
1999
2000
2001
2002
Source: CMI Farmexpert
Figure 3.11.1 The share of the Russian pharmaceutical sector

controlled by Russian companies
the pharmaceutical market are growing, the market share of the
Russian producers is steadily declining. We believe that the main
reason for this is the Russian producers lack of funds to upgrade their
basic assets and increase production they simply fail to keep pace
with market growth. A constant factor of the Russian producers weakening market position is their failure to ensure they have the required
range of medicines, which is mainly due to lack of funds for their own
development or for the purchase of licences for production of foreign
medications. As a result, the Russian pharmaceutical industry is based
on the production of old medicaments and generics replications of
popular drugs that no longer have valid patent protection.
Eastern Europe
24%
India
6%
Western Europe
64%
Others
2%
CIS
1%
USA
1%
Baltic states
2%
Source: CMI Farmexpert
Figure 3.11.2 Countries supplying pharmaceutical products into Russia
193
Furthermore, the production of generics is becoming quite complicated due to the strengthening of patent control. Russian producers are
becoming absolutely defenseless against importers, especially as at the
moment no Russian enterprise fully complies with the international
Good Manufacturing Practice (GMP) standards. The best that Russian
producers tend to achieve is compliance with GMP using different technological methods.
A special feature of the Russian pharmaceutical sector is also
connected to the fact that the enterprises sell their products only in
Russia and some CIS countries. Such tightness of the retail market is
the result of a poor range and quality of product that does not allow the
companies to capture a decent share of the overseas market. In fact, in
the domestic market the medications made in Russia are being
steadily directed into the low-income consumer sector. In this environment, changes in the Russian pharmaceutical sector are defined,
first of all, by the increase in living standards and, as a result, changes
in customer preference.
The market is to grow quantitatively, but not

qualitatively
Data from Goskomstat suggests that the pharmaceutical sector in
Russia is growing quite rapidly the overall production in the sector
increased in real terms by 5.6 per cent in the first quarter of 2004
compared to same period of 2003. But despite that, the market itself is
growing much slower. According to the experts estimates, the incremental growth of consumption in real terms was over 12 per cent,
without taking into account shadow (black market) turnover and fake
medicines, which play an important role in the Russian market.
Currently the volume of the legitimate share of the pharmaceutical
market is around $2.8 billion, while another $700$800 million represents the volume comprising the shadow economy. However, according
to expert estimates, there was a significant increase of actual
consumption only in the lowest price group of goods; all other groups
experienced a shift of demand towards expensive and effective
medicines of better quality.
The potential of the pharmaceutical market remains very large.
According to expert estimates, an average Russian consumes fewer
drugs today than in the Soviet times. Nevertheless, we doubt that the
growth dynamics of the sector will be very positive, as the volume of
drugs consumption is highly dependent on the level of personal income,
which is still quite low.
In terms of consumption of products in the industry in 2002,
according to data from Komkon-Farma, only a small proportion of
consumers who spend a minimum of $5 p.a. on drugs increased their
194
Market Potential
spending by 12 per cent. The number of Russians spending over $15

p.a. on drugs increased by as much as 5 per cent compared to the
previous year. The largest group with consumption in the range of
$5$15 p.a. fell by 7.4 per cent compared to 2001. Thus, we may sum up
that the total consumption of drugs in 2002 experienced almost no
growth, and in fact the demand shifted towards the more expensive
and efficient medicines.
Production and producers

The year 2002 was rich with innovations in the pharmaceutical sector,
which were mainly a result of government policies but also the result of
large corporate events. A 10 per cent VAT on drugs introduced at the
beginning of 2002 has changed the market landscape significantly. It
caused a reduction in production volumes and imported deliveries in
2002 compared to 2001. Profit tax relief for the pharmaceutical
companies was likewise removed.
The overall financial results demonstrate that the market is experiencing a period of stagnation. Despite the fact that in cash terms the
pharmaceutical sector grew by 12 per cent and reached the amount of
$2.8 billion, in real terms it fell by 10 per cent. This contradiction is
easy to explain, however. At the end of 2001 importers bought a huge
amount of medicines before VAT was introduced. Later these products
were sold from their warehouses. Also, the increase in turnover was
underpinned by appreciation of the euro, as the bulk of imported drugs
are delivered through Europe.
According to the overall results from 2002, the output of drugs
manufactured in Russia fell by 3 per cent in cash terms and totalled
$865 million compared with $896 million in 2001. It is difficult for
Russian producers to compete favourably with Western companies in
this unstable economic environment. But certain successes are worth
mentioning. Brand promotion complies with Western standards and
importers treat the issue of competition with Russian pharmaceutical
companies quite seriously.
Is the black market the leader of growth?

The black market for medicines in Russia is estimated to be at least
$250$300 million, according to Gostorginspection of MEDT of Russia.
This implies that around 10 per cent of the overall sales of drugs are
fabricated products, and 67 per cent of the overall amount of these
fabricants are produced in Russia.
According to non-official data, illegal sales are $1 billion p.a. and the
black market is growing much faster than the legitimate market. In
2002, the share of fabricants increased by 140 per cent compared to
2001, but the actual volume of fabricated products might be larger. The
195
most popular violations in the trading of medicines relate to breach of

storage and sales regulations, and the sale of products passed their
expiry date.
From a customers point of view, a fabricated medicine is a fraudulent product that might damage health. From a professionals point of
view it is:
a medicine accompanied by false information about its composition
and/or producer, in other words, produced with breach of patent law
or without a license; or
medicine packaged without comprehensive information, medicines
with expired expiration date, and medicine with an incorrect composition of active ingredients.
The products in the second group (the majority of fabricants) are often
harmless but undermine positions of the State and producers.
A new Pharmaceutical Inspection has been created in the Ministry
of Healthcare of Russia, in addition to the system of licensing introduced by the Ministry, and its function of control over the pharmaceutical sector is confirmed by the Law. The Inspection is authorized to
check all medical products supplied to the regions, issue certificates of
compliance and so on. New rules of certification for all medicines,
without exception, were introduced on 15 December 2002. No regulation can be identified either in the Criminal Code or the
Administrative Code for production and sale of fabricated or
substandard medicines. Inspectors will be actively suspending licences
and refusing to certify medicines. These remain the only mechanisms
that the State can employ against unscrupulous players.
However, the certification of medicines has not changed the situation in the pharmaceutical sector thus far. In 2002 the
Pharmaceutical Inspection captured only an insignificant volume of
fabricated products, with a total value of 7 million roubles (approx.
$200,000). Fraud is mostly uncovered during public procurement of
medicines.
A black list, of companies will soon be created. The regional
healthcare authorities and medical networks operators will be able to
identify from the list those companies with whom they should avoid
dealing. The Ministry of Healthcare believes that such measures,
accompanied by changing the regulatory regime for certification of
medicines, will result in the establishment of order in the pharmaceutical industry. Furthermore, the high volumes of the certification of
imported medicines will also give a competitive advantage to the
Russian producers.
196
Market Potential
Investment barriers in sector

Three main factors underpin the low investment attractiveness of
pharmaceutical companies:
low profitability of the business and strong competition from
importers;
lack of transparency of the companies, combined with very low
concentration of production;
extremely low liquidity of shares of pharmaceuticals. The narrowest
spread of a bid and an offer is over 100 per cent.
Low profitability
There are over 150 companies operating in the Russian pharmaceutical sector. However, only 70 companies have any significant turnover
(over $1 million) and just a few companies operate with an income
margin over 3 per cent. The overall financial situation in the sector is
deteriorating. The pharmaceutical sector is not particularly attractive
for investors mainly due to tough pressure from importers and the
dumping of fake products onto the market by Russian producers. For
example, in 2001 the overall revenue of the 50 largest Russian
producers was some $914 million, and the overall profit was $87
million. During 2002 the overall sales increased by 9 per cent (up to
$970 million), but profit decreased by 35 per cent (down to $57 million).
This means that the production of medicines is becoming a less
profitable business despite the overall growth of the market.
In theory, the potential of the pharmaceutical sector is quite large. If
the welfare of the Russian people increases, their spending on drugs
will grow exponentially. At present, the average amount spent by a
Russian on drugs is less than $10 p.a., but in about 35 years the
amount spent might reach $1520 p.a. However, only the largest
companies will benefit from this growth in the market, as they are the
ones actively investing in their own production and capable of
upgrading their equipment to fit GMG standards, which will become
obligatory for Russian producers after 2005. Naturally low profitability
and strong pressure from importers leave Russian producers only one
possible way forward to enlarge their businesses. Only if they achieve
this, will it become possible to turn the pharmaceutical business into a
genuine business, with reduced expenses on marketing and research.
Only large companies will be able to access the capital markets and
attract investments. The consolidation process has already started.
There are three operating holdings in Russia at present. Their overall
annual sales exceed $320 million. However, even the largest companies
remain non-transparent for investors.
197
Lack of transparency
The majority of pharmaceutical companies operate in almost full
isolation from the external world. Even the largest holdings often do
not have PR services or an Internet site. The only information that
leaks out from the sector is obligatory financial reports prepared by
companies and submitted to the FCSM and Goskomstat. Shareholders
and investors gain access to these reports only after significant delay
and sometimes they may not be published at all.
Under these conditions, investing in the pharmaceutical industry is
a bit of a lottery, as it is risky to rely on the company reports, especially
those prepared on the basis of Russian accounting standards. To
forecast future results is even more difficult as the internal processes
in the sector make it difficult to estimate the development trends of
individual companies within it. This problem will be solved only with
enlargement of companies and their subsequent access to the capital
markets, when the transparency of their information will ensure the
attraction of investment.
Low liquidity
Probably, one of the biggest problems facing an investor taking the risk
of making portfolio investments into the industry is the liquidity of
shares, or more precisely the lack of it. The majority of companies are
either state-owned companies (GUP, FGUP) or closed companies
(OOO, ZAO) as identified by their type of ownership. Those companies
that are officially called joint stock companies in practice are in essence
not different from ZAO (closed companies), as they also have a limited
number of shareholders and they are likewise isolated from the rest of
the world. In theory, an investor can buy shares in only eight
companies in the market, and only three of these have a listing on the
stock exchange (shares of other companies are available only via the
phone, off-board market). Nevertheless, the presence of a company on
the RTS or MICEX boards does not make its shares more liquid. For
example, there is no quotation for the shares of the holding Drugstores
36.6, which completed the IPO on MICEX not long ago. Shares of
Biokhimik, Farmakon and Krasfarma are in the same situation. At
best, spread between a bid and an offer is over 100 per cent, at worst
there is no quotation at all. Thus, the low liquidity of shares in pharmaceuticals automatically implies fixed limited periods of investments. We believe that the minimal period of purchase of shares in
Russian pharmaceutical producers is one year.
3.12
The Development of
Retail
Alexander Raifeld and Andrei Kouzmin,
Deloitte & Touche
Introduction
Retail is arguably the fastest developing industry in Russia. Starting
in 1999, the country has made a fast recovery from the economic crisis.
Its GDP has grown at an average of 6.3 per cent per year resulting in
remarkable growth over the five-year period. This, against a backdrop
of a declining population, has meant that per capita GDP has grown
even faster. In addition to this, inflation has slowed down and is
nearing its critical single-digit level. President Putin, who came to
power in 2000, has continued and further strengthened the liberalization process that was already taking place within the Russian
economy. Over the past few years Russian legislative bodies have
approved many laws aimed at increasing the efficiency of the domestic
economy and decreasing the countrys dependence on oil monopolies.
The political and social stabilization has inspired confidence in foreign
investors and the amount of direct and indirect investment in Russia
has increased greatly.
Retail has probably benefited the most from these changes. Russian
retail chains have grown extraordinarily in size, fully satisfying
consumer demand in Moscow and aggressively expanding into other
regions. Major Russian retailers have acquired world-class expertise
and developed their retail formats based on best Western benchmark
operations. Some of the global retailers have also entered into the
Russian market by opening their first stores in Moscow over the past
three years. Western companies such as Metro, IKEA, Auchan, Obi and
others are enjoying great demand within the Russian market. The
performance of these companies has exceeded all expectations.
The Development of Retail
199
Domestic consumers have benefited from lower prices and better

service as a result of the competition between domestic and Western
retailers. However, all of the above only really applies to Moscow. There
is still an enormous unrealized growth potential in the industry for
both domestic and international retailers to expand into the countrys
regions.
Macroeconomic trends
Russia has experienced a surprisingly robust economic turnaround
since the 1998 crisis. The countrys GDP has risen dramatically,
reaching approximately $380 billion in 2003. Economic growth has
been based mainly on high oil prices, which have provided solid profits
for domestic oil companies and strong tax revenues for the federal
government. This favourable macroeconomic factor was used to
strengthen domestic industries and to reorganize some of Russias key
industries. Vladimir Putin has also worked hard to reduce corruption
within the State. Although corruption persists, it has diminished
greatly since the 1990s. Another major achievement of the past few
years is the stabilized social environment within the country.
All these steps have had a major influence on Russias political and
economic situation. Western companies have become more willing to
invest in Russia. BMW, Ford, Mars, Gillette and others have opened
factories here. British Petroleum has made a $3 billion direct
investment in Russian TNK Oil Company. The economy has clearly
benefited from accelerated foreign investment, a reflection of the
increasing regard with which foreign investors hold Russia. They
believe that Russia has turned the corner, having tackled corruption
and accelerated the reform process. Indeed Russias government debt
has now achieved investment grade status, something that cannot be
said for many leading Western corporations, reflecting confidence in
the integrity of the countrys financial management.
A significant growth in the disposable incomes of the Russian population coupled with increased future confidence has brought about an
explosion in consumer spending. In 2003 real incomes grew by 14.5 per
cent while real wages increased by 10.4 per cent and the retail industry
was the greatest beneficiary of these trends. The turnover of Russian
retail grew by 10.6 per cent in 2002 and by 8.0 per cent in 2003 to
amount to $154 billion. The industry has become more structured and
sophisticated. The number of self-service stores has risen dramatically,
as consumers have been introduced to new store formats.
Hypermarkets, discount outlets, DIY and cash-and-carry formats
have quickly found their market niches. We believe that retail will
continue to develop quickly in Russia due to the countrys positive
200
Market Potential
macroeconomic outlook and the fact that the national GDP is projected
to grow 57 per cent annually until the year 2010. Moreover as the
country begins to invest in non-oil related industries, more regions will
be able to afford modern self-service retail outlets. Thus we believe that
the recent macroeconomic trends provide a solid foundation for future
development of retail.
Major trends in Russian retail

Russian retail in 2003 has been characterized by three major trends:
the arrival of foreign players, the expansion into the regions by both
domestic and international operators, and the rapid construction of
modern shopping malls. These trends have had a major shaping
influence on the Russian retail sector. We also consider them to be key
determining factors in the industrys development.
Positive changes in the economic, political and social situation in
Russia have made Western companies more willing to invest in the
country. They have also been impressed by the positive experience of
early investors in the Russian retail sector. The principal success
stories were Ramenka, a Turkish hypermarket operator (Ramstore
brand), and IKEA, the Swedish furniture retailer. In the latter case,
IKEAs first store has been so successful that its primary challenge has
been to supply enough merchandise to the store so it could to satisfy
consumer demand. Now IKEA is expanding its operations in Russia.
Not only is it opening new stores, it is developing sourcing relations
within Russia, to supply its Russian stores and to supply stores
throughout Europe. Moreover, IKEA is involved in developing
shopping centres, an important new type of shopping venue for Russia.
Ramenka was similarly successful with its Ramstore hypermarkets
and supermarkets. Currently the company operates 26 stores in
Moscow and in two other major Russian cities. It is these positive
examples that have increased Western companies willingness to
invest in Russia.
Recently a few major European companies have opened their stores in
Moscow. The most prominent ones are Germanys Metro, a cash-andcarry operation, Auchan, the French hypermarket chain, and Obi, a
German DIY retailer. Metro expects to have 20 stores in Russia by the
end of 2005. Six cash-and-carry stores were operating in 2003. The next
14 stores will include several Real hypermarkets, as well as Media Markt
electronic stores. Auchan has three hugely successful hypermarkets
already and the company plans to have 10 hypermarkets in operation
within the next two or three years. Meanwhile, Obi opened its two stores
in Moscow at the end of 2003. Other major global retailers known to be
closely considering Russia are Carrefour, Tesco and Wal-Mart.
201
The other major trend is expansion into the regions by major

domestic retailers. As the Moscow market becomes more and more
crowded and the level of disposable income increases throughout the
country, regional expansion becomes increasingly attractive. Almost all
major retailers have opened their stores in major cities throughout
Russia. Electronic retailers, some grocery stores, and a DIY chain,
Starik Hottabych, are especially notable for establishing their regional
presence. Eldorado, the largest Russian retailer, operates 439 stores in
295 cities. Pyaterochka, the leading grocery discount chain, has
developed a very popular franchise programme and therefore has been
successful in developing its national network. Metro has opened its
first stores in St.Petersburg. IKEA is rapidly developing its regional
network as well. We believe this trend will continue over the next few
years as retailers try to occupy new local markets for themselves.
Retailers understand the importance of establishing a presence in the
regions ahead of competitors. We expect the market share of selfservice chain stores will increase quickly in the regions.
Finally, the third trend that characterizes the development of
Russian retail is the construction of modern shopping malls. Two major
historical Moscow shopping centres, GUM and TSUM, are currently
undergoing major renovation and market repositioning. The operators
of these buildings plan to turn them into modern shopping centres with
a full array of goods and services for consumers. In addition to that a
large number of malls have been constructed in Moscow and other
major Russian cities. Among the new largest Moscow malls are the
Mega Mall, Atrium, Crocus City Mall, Rublevsky, Ramstore-City and
others. Mega Mall occupies approximately two million square feet
hosting three anchor stores IKEA, Auchan and Obi, as well as an
array of smaller retailers. Within the past couple of years shopping
centres have become attractive to many Muscovites. People appreciate
the extensive range of stores and entertainment facilities. We are
confident that many new malls will be constructed not only in Moscow,
but in all major Russian cities over the next few years.
Russias largest retailers

Supermarkets
Perekriostok, Ramstore and Sedmoy Kontinent (The Seventh
Continent) are the three major supermarket operators in Russia.
These companies are based in Moscow, they each operate a chain of 20
to 50 stores and generate an annual revenue of $300400 million.
These companies possess a very strong world-class expertise in food
retail; we expect them to continue expansion both within and outside
the Moscow city region. Food retail is arguably the best-developed
202
Market Potential
sector of the industry and consequently, is one of the most competitive

ones. As competition increases in Moscow, these companies will move
to other regions to open new markets for themselves.
Discount outlets
Discount chains arrived in Russia relatively recently, yet they have
been able to find a large market niche by providing customers with
high-quality low-cost products. Pyaterochka and Kopeyka are the two
largest retailers in this format. Pyaterochkas sales exceeded $700
million in 2003, making the company Russias second largest retailer.
The company itself operates a total of 172 stores in Moscow and St.
Petersburg. It also has 47 stores working in five other Russian cities
under franchise and the company is currently completing its state-ofthe-art distribution centre. Discount outlets have a very high chance of
success in the regions, as the average income level there is significantly
lower than it is in Moscow.
Electronics
Electronics stores are perhaps the best-developed in Russia. There are a
few sector leaders, such as Eldorado, M-Video, MIR, Technosila, and
Partya. Eldorado is the largest retail company in Russia with its annual
sales exceeding $1 billion. The company has been able to establish its
presence in all major Russian and CIS cities. The company established
its first Russian nation-wide store network by opening branches in all
the nations regions. Eldorado has pursued a low-price strategy, undercutting its high-margin rivals. Its aggressive marketing strategy allows
the company to attract consumers away from its competitors. M-Video
is the third largest Russian retailer with its sales approaching $573
million. Electronics retailers have been the most active in building their
stores in the regions. They have accumulated the necessary skills and
experience as well as the finances to edge out the local retailers.
DIY
Starik Hottabych, Russias first DIY operator, has been very
successful. The Moscow-based company has moved into the regions,
opening its stores in key Russian cities. Currently the company
operates 19 stores in Moscow and 11 stores in different cities
throughout the country. The companys success is based on its strong
focus in certain categories, such as ceramic tiles, carpeting, bathroom
accessories and flawless execution of merchandise planning and
selection. The company has been preparing for the mass arrival of
Western DIY leaders, such as Obi and Marktkauf, who opened their
first store in Russia last year. We believe that the DIY retail segment
will develop rapidly throughout Russia, primarily due to the presently
203
unsaturated market and high consumer demand. Local players, such

as Starik Hottabych, will be under severe pressure in Moscow, as the
foreign retailers move in. It will force Moscow-based local retailers to
intensify their regional development.
Cash-and-Carry
Metro was the first Western company to enter the Russian market with
its cash-and-carry format. The company presently operates six outlets
and announced plans to invest an additional $1 billion into its retail
network over the next four to five years. It plans to develop its
wholesale business and open up to 20 Real hypermarkets. Lenta is the
most successful Russian cash-and-carry operator, although its format
is more like US-style warehouse clubs. The company is based in St.
Petersburg and is planning to start expansion into the regions next
year. We believe that the cash-and-carry format can be successfully
replicated in all major cities throughout Russia.
Hypermarkets
The Turkish retail chain Ramenka was the first one to build hypermarkets in Russia in 1997. Since then, several other players have
pursued this format. The most successful entry into the Russian
market has been made by Auchan, a French retailer. According to unofficial sources, the turnover of an average Moscow Auchan is close to
$400,000, which greatly exceeds comparable Western operations.
Another promising Moscow player is Mosmart, which is currently operating one hypermarket and is in the process of building several more.
The company was able to attract Western specialists, who developed a
similar format in Poland.
Perfumes
Arbat Prestige is a leading Moscow-based cosmetics and fragrances
retailer. The company achieved sales of $200 million in 2003. Arbat
Prestige has become a widely recognized brand due to its aggressive
marketing policy and a strong merchandising programme. One of its
rivals, LEtoile, recently purchased a franchise from Sephora, a world
leader in cosmetics retail. We believe that the fragrances market will
become more competitive as more foreign companies continue to
establish their presence in Russia.
Luxury clothes and accessories

One could say that in terms of the luxury goods market, Moscow is on
par with Europes and Americas largest cities. The three largest luxury
retailers are Bosco Di Chiliegi, DjamilCo and Mercury, with the latter
204
Market Potential
being the sectors largest company with estimated sales of $250 million
in 2003. Mercury occupies a large market niche selling various luxury
goods from watches and jewelry, to top-brand clothes and luxury cars.
Both Bosco and Mercury purchased historical shopping malls in the
centre of Moscow, planning to develop them into upscale modern retail
complexes. There are many smaller niche players in this retail market
segment, serving a variety of tastes of local elite clientele. Moscowbased luxury goods retailers started to establish their presence in
other Russian cities by opening their stores in other high-income
regions and major cities.
Future outlook
We believe that the Russian retail industry will continue to develop
according to present trends. The local retail market will become more
sophisticated as the number of open-air markets and kiosks continues
to diminish. Russians are slowly become more discriminating as
consumers and local retailers are trying to improve their services to
retain customer loyalty. We predict the future development and
specialization of retail formats, with domestic retailers becoming even
more professional and efficient as they compete with established
Western companies. Regional expansion will continue to take place as
both Russian and Western retailers open branches throughout Russia.
Shopping malls will become a hot topic for the next few years. This is
especially true given the fact that most Russian cities have available
space for shopping centre development. Modern shopping malls will
not only provide convenient shopping for local residents but will also
serve as entertainment complexes.
We also expect more successful foreign retailers to enter the Russian
market in the medium term. Wal-Mart, Carrefour and other possible
entrants will bring their own expertise, thus making retail in Russia
even more efficient and competitive.
Conclusion
We believe that there is enormous unrealized growth potential within
the Russian retail sector. So far only selected Moscow retail chains
operate to Western standards. The development of modern retail
formats in the regions, coupled with a fast-growing level in disposable
income, creates a unique opportunity for both local and foreign
retailers. We expect the retail industry to grow at a rate, exceeding
those of most other sectors of the economy. We see unique opportunities
in Russian retail as the country quickly accumulates wealth and moves
towards a consumer society and market economy.
3.13
The Brewing Industry

Deloitte & Touche
Market potential
Over the past six years, the Russian beer industry has experienced a
real boom. Since 1998 the Russian beer market has grown an average
of 16 per cent per annum. This is in stark contrast to developed countries, where the beer industry is mature and has limited growth opportunities. The transition to a market economy in Russia has also
changed lifestyles among part of the population, encouraging a shift
away from hard alcohol. Beer has become increasingly seen as a social
drink on par with traditional vodka. According to industry experts,
beer sales rose to approximately 40 per cent of the drinks market in
2003. The Russian Brewery estimates that in 2004 vodka and beer
spending will be 36.6 per cent and 39.7 per cent correspondingly. Beer
demand rose from 47 litres per person per year in 2002 to 49 litres per
person last year.1 This consumption is still low in comparison with
other European countries (eg in the Czech Republic it is 160180, and
the world average is 60 litres per year) and thus could still have some
growth potential.
In 20002001, most analysts were overly optimistic about beer
market growth prospects, forecasting long-term growth of over 20 per
cent per annum. However, the market situation proved different in 2002,
when growth stopped. Between January and May 2003, production fell
by 1.2 per cent and in June 2003 (the hottest time for brewers) it was 8
per cent lower compared to the same period in 2002. According to the
results of the first quarter of 2003, production in value terms shrank by
five per cent reaching $140.1 million as opposed to $147.3 million in the
same period last year. At the same time volume grew by some 4.2 per
cent (732 million decilitres), also falling short of analysts expectations.
Thus, beer production is still growing in volume terms, however at a
significantly lower rate. This is no wonder, as beer market development
prospects largely depend on the growth in beer price compared to other
1
According to EIU.
206
Market Potential
alcohol. In the past the development of the beer market has clearly been
affected by variations of excise taxes and changes in barriers to the
distribution of cheap illegally produced alcohol. Consumption in terms of
pure alcohol volume per capita has been impressively stable over the
past two to three decades. This is due not only to changing drinking
habits but also to the change in relative price. Thus, growth deceleration
can, to a large extent, be attributed to the introduction of a higher 25 per
cent excise on beer from 1 January 2003. The other factor could be
changes and restrictions in advertising campaigns that came in due to
the anticipated banning of beer commercials by the Duma. Nevertheless,
the general growth in production continues. According to various
estimates, in 2004 it will amount to 58 per cent.
The brewing industry has attracted about $1 billion in investment
during the past five years, and domestic brewers are expanding
production to meet the increasing demand. The size of the Russian beer
market is now estimated at about $5 billion. By 2008 it will be worth
even more. Investments in the industry are guaranteed for the coming
45 years, due to the anticipated long-term market growth. At the same
time it is critical for investors to evaluate market potential, existing
brewing capacity and distribution constraints, before investing.
Demographics and market characteristics

Young Russian consumers aged 1835 have shown a clear preference
for beer over vodka and other spirits, and this preference continues to
strengthen and gain momentum. Brand awareness, once considered a
capitalist manifestation and a scourge to be avoided, is likely to take
hold as these educated consumers become increasingly dependent on
brands to ensure consistent and world-class quality. However, industry
analysts have noticed that consumers are still eager to explore new
brands and, in general, brand loyalty remains low.
The major market participants invest heavily in advertising in the
hope of developing the brand equity seen by their counterparts in
established European, Asian and US markets. The competition is so
high that advertising continues all the year round. Russian beer
marketers spend about $90 million a year on advertising. Advertising
is centred on television, radio and, to a lesser extent, print media.
However, breweries have recently come under fire for allegedly
targeting underage consumers. This criticism culminated in potential
restrictions being imposed on beer advertising. On 16 September 2002
the State Duma passed the second reading of changes to the law on
advertising, which would ban beer advertisements between 5pm and
10pm and the use of people or animals in beer ads. Although the
restrictions have yet to become law it is a clear indicator that there will
be some regulation of beer advertising in the future.
207
A few beer festivals have also sprung up, mainly in St. Petersburg
and Moscow, attracting thousands each year. Point-of-sale advertising
has begun in bars and restaurants. However, kiosks, which still
account for the majority of sales, present their own unique problems.
Geographical trends are also clear. Moscow and St. Petersburg have
a per capita consumption twice the average of other regions; however,
less than one-tenth of the population lives in these two cities. Brewers
must not only have a presence in Moscow and St. Petersburg, but also
Siberia and the Urals to be considered an industry leader. The
difference in these two markets further complicates this issue.
The capital cities: Moscow and St. Petersburg

Market saturation in Moscow and St. Petersburg (beer consumption
more than 60 litres per capita a year) approaches the lower average
European level (80 litres per capita a year). Analysts identify greater
customer sophistication and an increase in price competition.
The Moscow and St. Petersburg markets are dominated by
consumers with higher disposable incomes, who are more concerned
with quality and brand, although price still remains a factor. If the
economy is able to maintain its healthy growth rate, industry leaders
may be able to reap some rewards for the massive investments they
have made. However, it is clear that within the capital cities price is
less important among the young and affluent, but shows significantly
increased sensitivity among the less well off and consumers over 35.
This differs dramatically from the regions here price is the leading,
and some would argue the only, factor.
The regions
For those unfamiliar with the Russian market, the difference between
the capital cities and the regions can be mind-boggling to say the least.
Realistic estimates place the countrys wealth in its two historical
capitals anywhere from 30 to 35 per cent. While Moscow and St.
Petersburg have large populations with disposable incomes, vast
portions of the population in the regions have little, if any, disposable
income. Disposable income tends to be more concentrated in the hands
of a very few in the regions when compared to the capital cities.
These regional markets were traditionally served by low quality/low
cost manufacturers, not only in the case of beer, but also in that of all
consumer goods. Historically, only one brand was available.
Manufacturing decisions were based entirely on cost reduction implications. Advertising in the regions is difficult due to the lower population density. In addition, brand awareness and loyalty can seem
208
Market Potential
foolish to some people. At present, beer consumption per capita does

not exceed 20 litres a year per capita in some regions; for instance, in
Khabarovsk or Tumen, beer consumption amounts to 15 litres a year
per capita.
The regions have proved to be one of the most difficult issues facing
market leaders. While branding, advertising and quality control (areas
in which international brewers excel) work in the capital cities, price is
the leading factor in the regions. Another issue is the sheer size of the
regions. Operations in Vladivostok are geographically closer to the
capitals of Canada, the United States, Japan and China, than they are
to Moscow. Communications and travel logistics present another difficulty when managing these remote regions. Nevertheless, regional
expansion is vital for market players who wish to gain a leading
position in the Russian beer market.
The largest players have started considering establishing their own
production facilities to the east of the Ural Mountains. Krasny Vostok
opened a brewery in Novosibirsk in 2003 (its capacity is 30 million
decilitres) and Baltika built its brewery in Khabarovsk (10 million
decilitres). A branch of the Moscow-based Ochakovo will become operational in Tumen in 2004 (up to 15 million decilitres a year). Local
brewers have also started increasing production, such as the Omskbased Rosar (belonging to Sun Interbrew) and Pikra (belonging to
Baltic Beverages Holding). In the summer of 2003, three large brewing
companies SUN Interbrew, Efes and TSEPKO announced that they
planned to buy new breweries. All three companies demonstrate the
biggest interest in the markets of the Ural region, Siberia and the Far
East, where beer consumption is growing much faster than in the
European part of Russia. According to UFG, the capacity of the
Siberian beer market is 80 million decilitres a year and production
capacity in the region, taking into account the fact that breweries that
are not operational yet, amounts to 72 million decilitres.
Analysts view large-scale overproduction in Moscow and St.
Petersburg as the main reason for large brewing companies interest in
regional expansion. It is logical to presume that if growth slowed down
slightly in Moscow and St. Petersburg, the overall positive trend would
account for growth acceleration in the regional markets. Moreover the
relocation of production lets them save a lot of money. According to the
CEO of Business-Analytika, Andrei Sterlin, if companies start brewing
the beer in Siberia that they sell in Siberia, they will be able to save up
to 10 per cent on logistics and transportation.
Apart from the bottled beer market, the microbrewery/brewpub
market is beginning to develop in Russian regions. Siberia provides an
example of these developments in the Russian provinces. In Tomsk,
Tomsk Beer has opened a bar and restaurant complex adjacent to its
brewery, while the Omsk-based Sibirskaya Korona brewery (controlled
by Sun Interbrew) has established its own bar/restaurant in Tomsk.
209
Competitive situation
The Russian beer market underwent a fundamental change at the end
of 2002 switching from extensive growth to consolidation. The beer
market is already dominated by just three companies: Baltika, SUN
Interbrew and Ochakovo, which together claim more than 54 per cent
of the market. It is difficult to state the market share accurately, but
reasonable projections are shown in Tables 3.13.1 and 3.13.2.
Table 3.13.1 Market share
Producer
Share (%)
1H2003
Share (%)
2002
Baltic Beverages Holdings (BBH)

SUN Interbrew
Ochakovo
Krasniy Vostok
Heineken
Ivan Taranov Brewery (owned by Detroit Brewing)
Efes Brewery
Stepan Razin
SUBMiller
Others
Imports
33.4
13.5
7.5
7.0
4.6
4.1
3.3
2.1
2.0
21.5
1.0
32.8
12.5
8.3
7.1
4.1
5.0
2.7
2.6
1.9
22.0
1.0
Source: Reuters, UFG, Goskomstat, Annual reports, companies presentations
Table 3.13.2 Beer output by the major players, 2002

Producer
Baltic Beverages Holdings (BBH)
SUN Interbrew
Ochakovo
Krasniy Vostok
Ivan Taranov Brewery
(owned by Detroit Brewing)
Heineken
Efes Brewery
SUBMiller
Stepan Razin
Output 2002, HL mln.

16.1
8.1
5.7
5.2
3.2
2.8
2.6
1.8
1.7
Source: Renaissance Capital estimates
Three major trends that are expected to continue in the industry are
further consolidations, mainly through foreign direct investment,
210
Market Potential
struggling imports and regional expansion. The import segment, which

accounted for nearly 15 per cent of the market in 1996, was dramatically affected by the economic crisis of 1998 as consumers shifted their
loyalties to locally produced brands. The economic crisis, coupled with
improved branding and the quality of local products, drove imports
down to about 1 per cent in 2002. Many of the worlds largest brewers
have invested in the Russian market to capture the market share, not
only with locally-produced international brands, but also by investing
in the creation of Russian brands (see Table 3.13.3). Other international brewers, without local operations, have licensed the local
production of their international brands.
Table 3.13.3 Brewers and their brands
International brewer
International and local brands
Baltic Beverages Holdings
Yarpivo, Cheliabinskoe, Zolotoy Ural,

Kupecheskoe, Ubileynoe, Siberian Legend,
Baltika, Don, Arsenalnoe, Carlsberg, Parnas,
etc.
SUN Interbrew
Tolstyak, Klinskoe, Siberian Crownz, Stella

Artois, Volzhanin, Bavaria
SUBMiller
Zolotaya Bochka, Staropramen (Licensed),

Holsten (Licensed), Miller (Licensed), Tri
Bogatirya
Efes Beverages Group
Stary Melnik, Efes (Licensed)
Bravo (now Heineken)
Bochkarov, Lowenbrau (Licensed), Bear Beer

(Licensed), Ohota, Exportnoye, nonalcoholic
Buckler
Ivan Taranov Brewery
Pit, Tri Medvedya, Doctor Diesel, Gosser

(licensed, super premium brand)
Source: Renaissance Capital, Business Communication Agency
The brewing industry is one of the leaders in terms of attracting

foreign direct investment, with several major companies active in
Russia South African Brewers is in Kaluga, SUN Interbrew (BelgianIndian joint venture) in the Moscow region and Omsk, Efes (Turkey) in
the Moscow region, and Heineken in St. Petersburg. This influx of
foreign investment has engendered serious competition from Russian
brewers (St. Petersburgs Baltika dominates the market, while Kazans
Krasniy Vostok and Moscows Ochakovo are major players as well).
Foreign capital dominance in the beer industry continues to grow,
pushing out small domestic Russian brewers.
211
Branding: The national brand

As with all consumer goods, branding, once irrelevant in the Russian
market, has become critical. The value of branding can differ between
regions and between consumer groups. The race is on among the
leading brewers to develop and promote a strong national brand and
achieve national coverage.
Competition for consumers is becoming fierce against the background of slowing beer market growth. Brewing companies are
attempting to protect their positions with the assistance of new
brands, primarily in the premium segment, as price competition
results in margin erosion. For companies, profits lie in the perceived
extra value of brand names. And as the dominant brands establish
their positions, the focus of competition shifts.
Table 3.13.4 Key brands share of total market, 2002
Key Brands
Owner
Volume (%)
Share (%)
Baltika
Ochakovskoe
Arsenalnoye
Yarpivo
Klinskoye
Tolstyak
Volga
St. Razin
Bochkarev
Medovoye
Don
Okhota
Sib. Korona
Nevskoye
BBH
Ochakovo
BBH
BBH
SUN Interbrew
SUN Interbrew
BBH
St. Razin
Heineken
BBH
BBH
Heineken
SUN Interbrew
BBH
12.4
7.7
5.3
4.0
3.8
2.7
2.6
2.6
2.2
2.1
2.1
1.6
1.5
1.5
12.0
7.6
4.5
3.2
3.9
3.0
2.4
2.6
2.5
3.2
1.6
0.8
1.5
1.3
Source: Goskomstat, companies presentations
While some international brewers have introduced domestically

produced international brands, others have sought to further increase
the brand awareness of a number of their selected local brands. Baltika
launched four new brands with low-cost labels, packaging and advertising in March 2003. The new brands are called Krasnoyarskoye,
Krasnodarskoye, Tyumenskoye and Sverdlovskoye after the cities
where they will be marketed. Patra has added a new beer brand to its
product range the Knyazhe Gold. Vinap has closed beer production in
the Novosibirsk brewery, with production starting in the new Sobol
brewery with new brands Kaltenberg and Sobol being produced
212
Market Potential
alongside Zhigulyevskoe, the only one of seven previous brands to be

continued. For the Vena Brewery 2003 was a turning point: the
company rebranded their leader, Nevskoye, and also launched several
new brands, including Triumph and Kronverk. The Stepan Razin Plant
(St. Petersburg) invested $0.5 million into the production of Ordinar
Premium, a new beer brand, in 2003. The successful introduction of new
brands is partially explained by the fact that Russian consumers tend to
be more loyal to new brands than to old brands that have been changed.
Table 3.13.5 Beer market segmentation, 2001 and 2002 (%)
Segment share of total beer market
KupecheskoyeBavaria, Staropramen,
Heineken, Corona Extra, Fosters
Licensed
Miller, Lowenbrau, Holsten,
Staropramen, Efes, Stella Artois,
{Tuborg, Carlsberg}- BBH
Premium
Zolotaya Bochka, Stary Melnik, Solodov,
Bochkarev, {Baltika0, Baltika2, Baltika5,
Baltika7, Baltika 8 Parnas, Nevskoe}- BBH
Mainstream Sibirskaya Korona, Klinskoye, Tolstyak,
Stepan Razin,Volzhanin, Pit, Okhota,
{Baltika3, 4, 9, Sibirskaya Legenda,
Don, Yarpivo, Arsenalnoye, Medovoye,
ZolotoyUral, Kupecheskoye}
Economy
Ohakova, Krasny Vostok,
{Voronezhskoye, Chelyabinskoye,
Uralskiy Master}
2002 (%)
2001 (%)
16
11
60
59
21
28
Import
Source: UFG, companies presentations
Overall, in the same year, mass-market brands lost their positions, and
premium brands gained them. The premium segment grew rapidly, not
only due to the appearance of new brands, but also as a result of
changing several old mass brands.
Quality matters
Overall beer consumption may continue to grow in the future, as
analysts predict, but it is already clear that the high-quality beers will
dominate the market.
Since the 1998 crisis, there have been great profits to be made by
investing heavily in domestic production facilities to meet new
demands for quality. Additionally, as competition heats up, larger
breweries have begun buying up smaller facilities. They have been
213
working hard to increase the quality of locally-supplied ingredients

and packaging materials, which is helping to cut operational costs and
keep standards high. The marketing of beer on tap, an area that was
almost entirely neglected during the Soviet era, has also been on the
increase, with consumers appreciating the quality improvement over
canned or bottled beers.
This high quality is supported by the fact that foreign brands are
seeking to produce their beers locally under licensing agreements.
Major international players have been quick to establish themselves in
this growing market. For instance, the Baltika Brewery has entered an
agreement with the Danish brewing company, Carlsberg, to produce
approximately 10,000 hectolitres per year in Baltikas plant in Rostovon-Don.
Active promotion of new kinds of beer packaging is another opportunity to increase sales. The effect of canned beer advertising is
evident. According to AC Nielsen, the share of canned beer sales grew
from 9 per cent between January and May 2002 to 12 per cent between
January and May 2003.
Distribution channels
While traditional bars, pubs, restaurants and food outlets have their
own slight deviations in the Russian market, no challenge is greater
than that of the Russian kiosk. The equivalent to Western convenience
stores, these independent outlets sell the vast majority of the
hectolitres consumed in the Russian Federation. Often stocked
through middlemen, they offer unique quality control issues to brewers
intent on maintaining brand loyalty. While the brewing techniques are
the primary focus for quality improvements, the brewers can lose all
control at the point of sale. Often, sales are of the lower quality brands,
which sell based on price. However, these issues create obstacles for
premium brands to overcome.
Table 3.13.6 Store classifications selling beer, March 2002 (%)
Store type
Mixed and food stores
Impulse kiosks and pavilions
Open markets
Beer sales
53%
38%
9%
Source: ACNielsen
Geographical and structural problems are specific to the beverages

industry in Russia. Russias size, the relatively low concentration of
214
Market Potential
population and weak retail network limit the opportunities for a greater
degree of market dominance. It is difficult and costly to get products
onto shelves the result is a dominance of locally-produced local brands
that holds back national consolidation. And it takes time for national
players to emerge and establish dominance in the local marketplace.
Focus
Acquiring local breweries, as opposed to greenfield projects, has driven
growth among the largest market players. In most instances, the local
authorities and the local management see these local entities as part of
the beverage market rather than the beer market. Many local Russian
beer companies also bottle local-branded soft drinks, mineral water,
juice or hard liquor. Larger brewers must constantly fight to maintain
their focus on beer. Some have maintained these side businesses;
others have spun them off or have simply stopped producing. As with
any acquisition in the former Soviet Union, the other assets accompanying the productive assets can present unique challenges to those
who do not have a clear mission.
Conclusion
Although market growth is slowing down, making industry watchers
nervous, the simple fact is that the Russian beer market remains
extremely attractive. The main reason for beer companies to invest in
Russia has not changed: Russia can still offer growth. There is additional growth in the regions, in shifting customers up to higher-margin
beer products, in diversifying packaging, and finally there is growth as
beer continues to replace other beverages among consumers in their
consumption patterns. The main difference now for companies is to
identify properly where the best opportunities are, whereas in the past
growth was so rapid it was not very important which space one
occupied in the market. Unlike some other consumer goods industries,
there will always be room for small niche players, but this space will
continually decrease and the niche must be better defined than simply
by geography.
With the challenges of branding, market segmentation and distribution high on CEO agendas, winners and losers will begin to emerge
over the next three to five years. It is estimated that the top three
companies will produce 75 per cent of beer sold by 2010. While local
antimonopoly committees will continue to scrutinize each acquisition
by local breweries, market forces will prove as efficient as ever and
drive the largest forward and the rest out or into niche roles.
Part Four
Getting Established:
The Taxation and Legal
Environment
4.1
Business Structures
CMS Cameron McKenna
Introduction
In the last few years Russia has introduced extensive corporate legislation governing the creation, management and liquidation of a range
of legal entities and other structures through which business may be
carried on. These include public and private companies, branches and
representative offices and limited and unlimited partnerships. A basic
description of each of these forms is set out in the Civil Code of 1994
and, in respect of some of the structures, further, more detailed regulations are set out in the laws governing particular types of structure, for
example, the Law on Joint Stock Companies of 1995 and the Law on
Limited Liability Companies of 1998.
The structures most commonly used or encountered by foreign
investors are the representative office, the limited liability company and
the joint stock company (of which there are two forms open or public
and closed or private). This chapter will focus on these principal forms.
Representative office
Status
A representative office with accredited status has been traditionally
viewed as the simplest form of business presence that a foreign
company could establish in Russia. In the USSR it was the only vehicle
available to foreign companies and although foreigners can now set up
a wholly-owned subsidiary company and may participate on an equal
basis in the various forms of partnership prescribed under Russian
law, a representative office remains an effective first entry vehicle
either alone or in conjunction with a company of some form. Some of
the reasons for this are explained below.
A representative office is not a separate legal entity but an office
of the parent entity that is set up in Russia to represent the interests of
218
Getting Established: The Taxation and Legal Environment
that parent. Although a representative office may in practice conduct

business in Russia and may be treated by the tax authorities as a
separate profit centre from its parent company, the fact that, as a
matter of civil law, a representative office does not have its own
separate legal identity limits the types of business for which a representative office may be useful. For example, a representative office may
not import goods for purposes other than its own needs, nor may it
register title to immovable property in its own name. A representative
office may also experience difficulties in obtaining licences and permits
to conduct certain types of business.
A representative office may, however, carry out representative functions on behalf of its parent, including arranging marketing and advertising in Russia, negotiating the terms and conditions of agreements on
behalf of the parent entity and facilitating the execution of those agreements by the parent company. It may also help in other commercial
and legal transactions between the parent and Russian organizations,
including the rental of property.
At one time an accredited representative office enjoyed a range of
benefits that were not available to branches or companies. These
benefits have been gradually withdrawn for example customs exemptions on equipment imported for the use of the representative office
were withdrawn in February 1999. Foreign employees of a representative office may still obtain personal accreditation, which confers
certain practical benefits such as the right to import and export
personal effects free of customs duty and VAT, and which assists with
obtaining multi-entry visas. There has been considerable debate about
whether accredited employees of a representative office require work
permits but in practice having a work permit should avoid difficulties
with Russian state and local migration authorities.
A significant advantage of a representative office is that it is not
deemed to be resident for Russian currency purposes and, therefore, its
foreign currency receipts are exempt from the mandatory requirement
to convert those receipts into roubles. A representative office may have
a number of different types of bank account: a foreign currency
account; a rouble conversion account (referred to as a type K account)
and a rouble non-conversion account (known as a type N account).
These accounts enable the representative office to make payments in
Russia to both residents and non-residents subject to certain currency
control restrictions established by the Central Bank regulations and
other applicable legislation. Proceeds from business operations may be
accumulated either in a type K or type N account (depending on the
type of proceeds) and, after conversion into foreign currency, may be
transferred abroad.
Business Structures
219
Liability
As a representative office is merely an extension of its parent, the
parent remains responsible for the debts and liabilities of the representative office.
Management
A representative office is managed by the Head of the Representative
Office, who is empowered to conduct the business of the office, and so
to represent the foreign parent company by way of a power of attorney.
A representative office should also have a Chief Accountant. There is
no requirement for either the Head of the Representative Office or the
Chief Accountant to be a Russian national, although an accountant
who understands the intricacies of Russian tax and accounting law is a
practical necessity. Since the foreign parent company is fully liable for
the debts and obligations of the representative office, some consideration should be given to the management of the office and any internal
controls that may be appropriate to mitigate the exposure of the parent
company.
Setting up a representative office is often the first step that foreign
companies take when entering the Russian market and may be used
for certain service industries on an ongoing basis. For companies in
many other business sectors, however, a representative office is not on
its own sufficient, although one may form part of a larger structure
including one or more companies or other entities.
Limited liability company (obshestvo s

ogranichennoi otvetstvennostyu)
Status
A limited liability company is designated by the letters OOO before or
after its name. It is the simplest form of Russian company and for that
reason is often used for wholly-owned subsidiary companies of foreign
investors. It is similar in concept to a German GmbH or limited
liability company.
The establishment of a limited liability company is governed by Part
1 of the Civil Code and by the Law on Limited Liability Companies of 8
February 1998. It shares many similarities with another form of
Russian company, the closed joint stock company, which is described
below. The most significant difference between a limited liability
company and a closed joint stock company is that a limited liability
company does not issue shares. The charter capital is instead divided
into participations or interest units (doli). Unlike shares issued by a
joint stock company, these interest units are not considered to be
220
securities and, therefore, do not need to be registered with the Federal

Commission for the Securities Market, which goes some way to
reducing the expenses of registration and also the level of bureaucracy
to be dealt with by the company. Each holder of an interest unit is
referred to as a participant. The liability of participants in the
company for the debts and obligations of the company is, as a general
principle, limited to the amount of their respective contributions.
A limited liability company may be wholly owned by another
business entity provided, however, that entity is not itself wholly
owned by a legal entity or individual. At the other extreme, if the
number of participants in the company exceeds 50 then, unless the
number of participants is reduced, the company is obliged to reregister as an open joint stock company within a year.
Management
The management structure of a limited liability company is relatively
straightforward and may consist of a general director and the meeting
of participants. A board of directors is not required but can be provided
for by the terms of the charter.
Although a participant of a limited liability company is generally
entitled to the number of votes at the general meeting of participants
that represents the value of his contribution to the companys capital,
this principle can be changed in the companys charter either when
establishing the company or by subsequent amendment to the charter,
which requires the approval of two-thirds of the companys participants.
Transfer of interest units

Interest units or participations in a limited liability company are freely
transferable, subject to a statutory right of pre-emption in favour of the
other participants. This right cannot be excluded from a companys
charter. Thus, a transfer to a third party can only take place once the
other participants have had the opportunity to purchase the interest.
The procedure for offering the interest units to the other participants
and for determining the price at which the units are offered is usually
set out in the companys charter.
The charter may even prohibit the transfer of an interest to a third
party in which case, if the other participants decline to purchase units
offered to them, the company itself is obliged by the Law on Limited
Liability Companies to purchase this interest. Payment may be in cash
or, with the agreement of the transferring participant, in kind. The
participant has the right to receive payment for its interest within six
months (unless a shorter period is provided for in the charter) of the
end of the accounting year in which the participant offered its interest
for sale.
Business Structures
221
Right to withdraw
Every participant of a limited liability company has the right to
withdraw from the company, at any time without the consent of any of
the other participants or of the company. If a participant exercises this
right then, the interest unit is transferred to the company with effect
from the time the withdrawal notice is served on the company. The
company is then obliged to pay the exiting participant the actual
value of his portion of the capital in cash. The actual value of the
participants interest will be calculated as a proportion of the net value
of the companys assets equal to the proportion of the companys
participation interests that he holds. Payment, however, is required to
be made within six months after the end of the companys financial
year in which the withdrawal notice was served. The company may pay
the exiting participant its entitlement in kind provided the participant
agrees to this.
This right to withdraw from a limited liability company cannot be
excluded by the charter. Any provisions eliminating or limiting the
right to withdraw are null and void. Although difficulties in valuing a
participants interest units and the procedure for repayment provides
some practical disincentive to withdrawal, the existence of the right
may undermine the usefulness of this type of corporate vehicle for
anything other than a wholly-owned subsidiary.
Open and closed joint stock companies

Status
The legislation governing a Russian joint stock company is to be found
in the Civil Code and the Joint Stock Company Law of 26 December
1995. The latest Law on Amendments to the Joint Stock Company Law
was published on 27 February 2003.
A joint stock company can either be open or closed. An open joint
stock company, (otkrytoye aktionernoye obshestvo) is designated by the
letters OAO and a closed joint stock company (zakrytoye aktionernoye
obshestvo), by the letters ZAO which appear either before or after the
companys name. The distinction between the two corporate vehicles
can be likened to that between a private company and a public
company in jurisdictions such as England and Wales. The open joint
stock company is the form used for public companies, as it can issue
shares to the public and such shares are freely transferable without
any pre-emption rights in favour of other shareholders or the company.
A closed joint stock company, on the other hand, is designed for private
or closely held companies and so, for example, cannot issue shares to
the public.
222
Like a limited liability company, a joint stock company may not be

wholly owned by another business entity, which in turn is wholly
owned by an individual or a single legal entity.
The maximum number of shareholders for a closed company is 50. If
this number is exceeded the company is obliged to re-register as an
open joint stock company. There is no limit to the number of shareholders in an open joint stock company.
Management
The management structure of a joint stock company consists of three
bodies: (i) the general meeting of shareholders; (ii) the board of
directors; and (iii) the executive body, which can be either collective (eg
a management board or board of directors), or a single individual, the
general director.
The general meeting of shareholders is the supreme corporate body
of a joint stock company and must be held annually. Extraordinary
meetings may be called by the board of directors on its own initiative or
on the initiative of the auditing commission, the independent auditor or
a holder(s) of more than 10 per cent of voting shares. The Law on Joint
Stock Companies defines certain decisions that are within the exclusive
authority of the general meeting of the shareholders and that may not
be delegated to any other management body within the company.
The board of directors is responsible for the general management of
the company and has authority to decide on almost any issue except
those within the exclusive competence of the general meeting of the
shareholders. In a joint stock company with less than 50 shareholders,
the functions of the board of directors may be performed by the general
meeting of shareholders and authority to run the day-to-day business
of the company can be delegated to the General Director. Directors are
elected by the general meeting of shareholders usually for the period of
one year but they may be re-elected any number of times.
The executive body of a joint stock company may consist of one
person, the General Director, or of a General Director and a group of
persons acting as a collective executive body. The executive body is
responsible for the day-to-day management of the company. The executive body of the joint stock company is elected by the general meeting
of shareholders unless the charter of the company transfers this
authority to the competence of the board of directors.
Issue and transfer of shares

An open joint stock company may make public offerings of its shares,
which are freely tradable on the market. There are no pre-emption
rights or restrictions on the transferability of shares in an open joint
stock company as there are for closed joint stock companies.
Business Structures
223
The shares of a joint stock company, whether open or closed, are

treated as securities and, as such, are subject to the registration
requirements of the Law on Securities Market of 22 April, 1996. When
issuing new shares therefore, all joint stock companies must prepare
and file with the Federal Commission for the Securities Market, a copy
of any decision to issue shares, a report on the results of the share issue
and, in certain cases, a prospectus for the share issue.
Title to shares in a joint stock company is determined by reference to
the register of shareholders, which all joint stock companies are
required to maintain. Share transfers take effect on their entry into the
register and the shareholders entitlement to participate in shareholders meetings is determined by the register. The register may be
kept by the company itself or by an independent registry company duly
licensed by the Federal Commission for the Securities Market. If the
company has 50 shareholders or more then the register must be kept
by an independent registrar.
Shares of a closed joint stock company may be distributed only to a
limited group of persons. A closed joint stock company may not publicly
offer its shares or otherwise offer them to an unlimited number of
investors.
The transfer of shares in a closed joint stock company, is subject to
pre-emption rights in favour of other shareholders. The procedure and
terms for the exercise of pre-emption rights should be specified in the
companys charter subject to the overriding requirements of the Joint
Stock Company Law, which provide that these rights must be exercised
within not less than 10 and not more than 60 days from the time the
shares are offered for sale and at the same price as offered to any third
person.
The strengthening of shareholders rights is seen as a priority issue
and there are a number of legislative and quasi-legislative initiatives
underway to address the many concerns that investors have expressed
about the corporate regulatory environment in Russia. The amendments made in August 2001 to the Joint Stock Company Law tidy up
and clarify the procedures for approving what are known as major and
interested party transactions by establishing more precise rules for
conducting such transactions. Another major development in Russia
has been the publication of a draft Code of Corporate Conduct, which
the Federal Commission for the Securities Market introduced in 2003.
The Code is based around the general principles set out in the
OECD Principles of Corporate Governance and is presently recommended for use by large joint stock companies. Like Corporate
Governance Codes in a number of other countries, the Russian Code
will not be legally binding, although it is expected that major joint
stock companies will incorporate most of the provisions of the Code
into their internal documents.
224
Recently, the Federal Commission for the Securities Market issued a

number of documents governing particular issues related to the
conduct of general meetings and other issues relevant to corporate
governance. By expanding in greater detail some of the basic rights
that shareholders are entitled to, such regulations should play a significant role in strengthening the protection provided to minority shareholder interests.
Other entities
The Civil Code provides for a range of other entities including branches
and simple partnerships which are not legal entities, as well as full and
limited partnerships and additional liability companies which are
legal entities. There are also non-commercial organizational forms that
may be used for charities, trade associations or other not-for-profit
organizations.
4.2
CMS Cameron McKenna
Introduction
Having decided the type of legal presence to establish in Russia, the
next step is to register the presence with the relevant authorities. The
registration procedure and the documents required for registration are
very similar for a limited liability company or a joint stock company
whether open or closed, while registration procedures for a representative office are different. As shares in a joint stock company, both open
and closed, are treated as securities, there are certain additional
requirements to register the securities with the Federal Commission
for the Securities Market (FSCM).
Although it may be possible to purchase a company off the shelf, the
registration requirements for transferring ownership of the shelf company,
changing the charter so that it reflects the business to be carried on by the
investor and changing the name is no less bureaucratic, burdensome and
time-consuming than setting up a new entity from scratch. In addition, it
may even be necessary to obtain the prior consent of the Anti-Monopoly
Ministry for the acquisition of a shelf company. This is the case if the
aggregate worldwide assets of the founders (and related companies) are
greater than $680,000 (being 200,000 times the statutory minimum
monthly wage, which on 1 January 2004 was 100 roubles or $3.4).
The registration procedure is quite simple, as in December 2000 the
government announced a plan to streamline the laws for registering
new companies by introducing a one-stop registration process to
reduce the time and cost it takes to establish a corporate vehicle, and
which procedure has been recently successfully implemented.
Registration authorities
Representative offices
The accreditation of a representative office involves obtaining a permit
from one of several federal accreditation agencies. Foreign companies
226
wishing to open a representative office in Russia usually choose between

the Chamber of Commerce and Industry of the Russian Federation, the
State Registration Chamber (SRC) of the Russian Federation, or the
Ministry of Foreign Economic Affairs of the Russian Federation.
Accreditation with any of these agencies enables a representative office
to operate at federal level irrespective of where the representative office
is physically located.
In addition to federal accreditation, a representative office must be
registered at the local level. This requires registration with the local
tax inspectorate, the Russian Federation State Committee on
Statistics and three employment-related funds, which collect
mandatory contributions from the payrolls of all entities operating in
Russia. Certain legal requirements that apply to the registration of a
company (see below), such as procuring a guarantee of a legal address
and the execution of a lease, also apply to a representative office and a
branch.
If the federal accreditation was granted by an agency other than the
SRC, the documents must also be filed with this agency, as the SRC
maintains the register of representative offices of all foreign companies
accredited in the Russian Federation.
Representative offices should also open one or more bank accounts,
and for practical purposes, arrange to have a seal.
Companies
Pursuant to the Law on Registration of Legal Entities (the Law on
Registration) as of 1 July 2002 the State Tax Ministry of the Russian
Federation is responsible for the registration of legal entities. The Law
on Registration made substantial changes to the procedure for the
registration and re-registration of legal entities (which was similar to
the registration procedure for representative offices, described above)
in that it transfers the function of registration to a single federal executive body the State Tax Ministry.
The Law on Registration establishes a uniform procedure for the
registration of legal entities regardless of their organizational and
legal form and the kinds of economic activities pursued by them.
Regional branches of the State Tax Ministry are required to carry out
registration in accordance with centrally prescribed rules. In accordance with Article 1 of the Law on Registration, the registration
process is governed by federal legislative acts. This provision is
intended to restrict the legislative powers of the regions.
Further, on 23 December 2003 the Russian President signed into
law amendments to the Law on Registration, which successfully
completed the implementation of the one-stop shop.
227
Registration procedure
The Law on Registration provides for a one-stop registration, avoiding
the need for registration or notification with numerous other authorities as was required before.
State registration of legal entities should be made within five
working days of the submission of the corresponding documents to the
local branch of the Tax Ministry. A legal entity shall be deemed to be
registered as soon as it is entered into the state register.
The application for registration and the requisite supporting documentation should be submitted to the local branch of the Tax Ministry
in the administrative district stated in the application for state registration as the seat of its permanent executive body. The Law on
Registration provides that the relevant documents can be submitted
personally by the applicant, by its authorized representative, or can be
sent by post. Upon receipt, the registration body is obliged to issue a
receipt to the applicant. If the documents are sent by post the registration body is required to send the receipt to the address of the
applicant by registered letter not later than the next day after the
receipt of the documents and to obtain a confirmation of delivery.
All other authorities will be informed of the registration of a legal
entity by the registration body and not by the applicant. The Tax
Ministry shall, within five working days of state registration of a
particular entity, provide registration data to employment-related
funds of the Russian Federation, so that such Funds can effect their
own registration of the entity (such as the Pension Fund, Social
Security Fund and Medical Fund). The Tax Ministry shall be required
to inform the employment-related funds not only of the fact of registration of a legal entity but also of all changes made to the data on such
legal entity contained in the register.
Registration documents for representative offices

A list of the documents required by the authorities for a foreign
company to register a representative office can be found in the
Appendix to this chapter. Many of the documents required are
straightforward, such as copies of incorporation certificates and copies
of articles of association or charters. Reference letters are, however,
required from third parties, including one from a bank in the home
jurisdiction of the foreign company.
The registration authorities apply strict rules both as to the form
and content of these documents and also as to the manner of their
execution. Incorporation certificates and articles of association must be
filed as notarized copies with an apostille affixed if originating from a
228
country that is a member of the Hague Convention, or, if from any

other country, the documents must be legalized. The procedure for
obtaining an apostille varies from country to country and an investor
should check with a locally-qualified notary or the requisite
government office to determine how and where to obtain an apostille.
Reference letters from the bank as well as the letter from the tax
authorities must also be notarized or have an apostille affixed, and
thus it is necessary for an investor to liaise with the bank/local tax
authorities to ensure that they understand the procedure to be
followed. If documents have not been submitted in the prescribed
manner the registration authorities may reject them and require them
to be re-submitted. Documents that are dated any more than six
months prior to the date they are filed with the Registration Chamber
will not be accepted.
All documents must be in Russian or have a certified translation
into Russian attached to them before the documents are submitted to
the registration authorities.
The exact procedure for registering representative offices and
companies may vary slightly from region to region within the Russian
Federation; for example, in certain regions tax authorities may require
a copy of an executed lease for office premises before it will register a
representative office or a company.
Legistration documents for legal entities

The Law reduces the number of documents for registration of a new
company to just four (five for entities with foreign participation) and
these are as follows (from 1 July 2003):
1. an application;
2. a resolution on the establishment of the legal entity;
3. constitutional documents (charter and foundation agreement or
decision on foundation); and
4. a document confirming the payment of the registration fee.
If one of the founders of the new company is a foreign legal entity, it
will also be required to submit an extract from its trade register
confirming its legal status. Other requirements with respect to the
form of the documents have been determined by various pieces of
Russian legislation. The documents prepared in foreign jurisdiction
must be notarized and apostilled (or legalized, as applicable) and
accompanied by a certified Russian translation.
The Law on Registration prohibits the registration authorities from
requiring any other documents.
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Contributions to capital
The minimum share or charter capital of a Russian closed joint stock
company or a limited liability company is 100 times the statuary
minimum monthly wage. On 1 January 2004 this was approximately
$3.40 and the minimum US dollar capital therefore was $340.
Contributions to the charter capital of the Russian company may be
made in cash or in kind. Contributions in kind may include securities,
property, property rights or other tangible or intangible rights having
monetary value. Certain rights that are granted exclusively to a shareholder or founder by Russian authorities for example, licences
cannot be contributed to the companys capital if they are not fully
transferable.
Exemptions from import duties and import VAT may be available for
certain types of equipment that are contributed to the charter capital
of a company by a foreign shareholder or participant. The equipment
must be categorized as a fixed industrial asset and must not be subject
to any Russian excise tax.
Generally any asset that is contributed to charter capital must be
valued by an independent valuer.
Formation of charter capital

No less than 50 per cent of the charter capital of a limited liability
company or a joint stock company must be contributed before the
company is registered. The outstanding balance must be paid within
one year from the date of the permanent registration certificate.
In order for a foreign investor to make cash contributions, an escrow
account must be opened with a Russian bank in the name of the
company being established.
Anti-Monopoly Ministry and FSCM

If the value of the assets contributed by the founders of a company is
greater than $680,000 (being 200,000 times the statutory monthly
minimum wage of 100 roubles as of 1 January 2004), the Anti-Monopoly
Ministry should be notified of the registration of the company within 45
days of its registration. The information to be supplied to the AntiMonopoly Ministry is prescribed by statute and the Anti-Monopoly
Ministry may cancel the registration if the establishment of an entity
may lead to a restraint of competition in the market. If an investor has
any concern that the Anti-Monopoly Ministry may challenge the registration, there is a pre-notification procedure that can be used.
230
Shares in any joint stock company, whether closed or open, are

considered securities and must be registered with the local subdivision
of the FSCM before the registration of the company is completed.
Appendix: Registration documents

The following is a list of basic documents for the accreditation of a
representative office of a foreign company in Russia:
1. Charter or Articles of Association of the parent company;
2. Certificate of Incorporation or Extract from the Trade Register for
the parent company;
3. reference letter from the parent companys bank;
4. Power of Attorney for the head of the representative office;
5. Power of Attorney to complete the accreditation and registration;
6. letter from the tax authorities confirming the registration of the
parent company with the tax authorities in the country of its residence;
7. resolution of the parent company or founder to set up a representative
office;
(Note: The above documents should be legalized or apostilled and a
certified Russian translation of the documents should be attached
to them.)
8. regulations of the representative office;
9. two letters of recommendation from Russian business partners;
and
10. a letter of consent from the local authorities approving the location
of the representative office (if it is to be established outside
Moscow).
4.3
Russian Business
Entities
Gennady Odarich, Lawyer,
PricewaterhouseCoopers CIS Law Offices BV
Introduction
Part One of the 1994 Civil Code contains the basic principles of the
creation, management and liquidation of legal entities. These aspects
of legal entities are regulated in greater detail by a number of subjectspecific laws such as the Joint Stock Companies Law of 1995 and the
Limited Liability Companies Law of 1998.
The following specific for-profit business forms are available:
full partnerships;
limited partnerships (kommandit partnerships);
limited liability companies;
additional liability companies;
production co-operatives;
joint stock companies (public and closed);
unitary enterprises (these are state-owned legal entities not
available to foreign investors).
Of the foregoing, only the joint stock company resembles a corporation, but the limited partnership and the limited and additional
liability companies also limit the liability of investors to the extent
described elsewhere in this chapter. This chapter concentrates on the
legal entities and its subdivisions that are most commonly selected by
foreign investors for setting up operations in the Russian Federation.
These are: joint stock companies (with two forms open (ie public) and
closed (ie private)), and limited liability companies as well as representative offices and branches of foreign legal entities.
232
Joint stock companies

The main laws governing joint stock companies (JSCs) are Part One of
the Civil Code and the Law On Joint Stock Companies of 1995, the
latter having been amended numerous times.
The Joint Stock Company Law defines a JSC as a company with
authorized capital that is divided into a specific number of shares; the
participants of a joint stock company (ie the shareholders) are not
liable for its obligations or any losses related to its activity only to the
extent of the value of their participatory interests.
The Russian Civil Code provides that only joint stock companies may
issue stock, which is considered a type of security under the law. A share
issuance must be registered with the Russian Federal Securities
Commission by filing a copy of the decision to issue the shares with the
share issuance prospectus and, thereafter, the report on the results of
share issue. All transactions involving the shares must be registered in
the JSC register, which can be maintained either by a licensed independent company or by the JSC itself. If the company has more than
499 shareholders, it must have a licensed independent company to
perform this function.
Management
The managing bodies of a joint stock company are:
The general meeting of the shareholders. This is the supreme body of
the joint stock company. The general meeting of shareholders is the
only body that may take major decisions on behalf of the JSC. It is the
only body of the JSC to decide about liquidation or reorganization of
the company, expansion or reduction of the stock, amendments to and
new editions of the charter, new shares issue and dividend amounts,
etc. The general meeting may not delegate such decisions to other
bodies or individuals. There are two types of general meetings: the
annual meeting, to be announced one month in advance; and the
extraordinary shareholders meeting, which can be held in addition
to the annual shareholders meeting and can be called by the board of
directors or at the initiative of an independent auditor or by the
holders of more then 10 per cent of the voting shares.
The board of directors. This is the general management body of the
joint stock company. It has the authority to take any decisions
except those that are subject to the general shareholders meeting.
The body can be either collective (required for JSCs with more than
50 shareholders) or single (ie an elected General Director).
The executive body. This is either a single general director or a
collective body that is responsible for implementing the decisions of
the general shareholders meeting and the board of directors.
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Open and closed joint stock companies

Russian legislation establishes two types of joint stock companies,
specifically, open (or public) and closed (or private). The main
distinctions between an OAO (the Russian acronym for open joint
stock companies) and a ZAO (the Russian acronym for a closed joint
stock company) are as follows:
Transferability of stock. While the stock of an OAO, as a rule, is
freely transferable, stock of a ZAO is subject to the pre-emptive
rights of other shareholders.
Limit on number of shareholders; open subscription. Only an OAO
has the right to offer its stock to an unlimited number of persons (in
what might be loosely referred to as a public offering). Thus, an
OAO is a vehicle for raising funds from investors in the stock
market. The number of shareholders of a ZAO is limited to 50.
A company may not have as a sole founder (or shareholder) another
company consisting of one shareholder. This means that a joint stock
company may not have as its sole founder or sole shareholder a
company that in turn is owned by a single person. This rule also applies
to limited liability companies.
Minimum capitalization requirements. The amount of the charter
capital of an OAO may not be less than 1,000 times the minimum
monthly wage (approximately $3,000 at the current exchange rate),
and the amount of charter capital of a ZAO may not be less than 100
times the minimum monthly wage (approximately $300 at the
current exchange rate).
Public disclosure. Public companies must make certain financial
and related information public each year.
Limited liability company

Overview
In accordance with the Russian Civil Code and the Law On Limited
Liability Companies (hereinafter OOO), an OOO is company founded
by one or several persons, its charter capital divided into participatory
shares in the amounts determined by the foundation documents; the
participants of an OOO are not liable for its obligations and bear the
risk of losses connected with the activity of OOO only to the extent of
the value of their contributions to it.
An OOO bears liability for its obligations with all of its property. The
maximum number of participants of an OOO is 50.
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Management
The management bodies of an OOO are:
Meeting of participants. This is the main governing body of an OOO.
The meeting of participants is the only body that may take major
decisions on behalf of an OOO, such as liquidation or reorganization
of the company, expansion or reduction of stock, amendments to the
foundation agreement and charter, adoption of annual accounting
reports and issue of debenture bonds and other issuing securities.
Each participants votes at the meeting are proportional to the value
of their contribution to the companys capital. This can be changed
by amendments to the charter.
General director. This is the managing body of the OOO, responsible
for implementing the companys policy.
The minimum amount of charter capital of an OOO is the same as that
for a ZAO (100 times the minimum monthly wage: approximately $300
at the current exchange rate).
Differences between ZAO and OOO

Both a ZAO and an OOO are deemed legal entities under Russian law
and are subject to the same corporate profits tax regime.
A ZAO and an OOO have very much in common. However, their
primary differences are:
1. Shares in a ZAO are deemed securities and, therefore, are subject to
registration with the Federal Securities Commission and payment
of a 0.8 per cent securities tax on additional share issuances. Shares
in a ZAO can be ordinary or preferred. A ZAOs shares of one and the
same category have the same rights. Shares in OOO are not deemed
securities and are exempt from the above requirements. All shares
(or participatory interests) in an OOO are equal, ie there are no
preferred shares. However, participants in an OOO can agree that
voting and/or dividend rights under their shares can be different, eg
a participant holding shares worth 20 per cent of the share capital of
an OOO can have 80 per cent of the votes at the general meeting and
dividends distribution and vice versa.
2. Shareholders decisions in a ZAO can be taken by a simple majority
vote or qualified majority vote (ie 75 per cent) of the shareholders
present at the meeting provided that there is a quorum (ie shareholders holding 50 per cent +1 share are present at the meeting). In
certain cases, the number of votes required for the adoption of a
resolution can be changed by the charter of the ZAO. A unanimous
235
vote in a ZAO is required only for a decision to convert the OOO into
a non-commercial partnership. In an OOO, shareholders decisions
can be taken by a majority, qualified majority or a unanimous vote of
the participants of the company regardless of whether a quorum is
present. The charter of an OOO can also provide that certain decisions require a higher number of votes than specified in the law.
3. Shareholders in a ZAO can only dispose of their investment in the
company by selling their shares to other shareholders or a third
party. In addition to sale, participants in an OOO have the right to
withdraw from the OOO at any time. In this case, their shares are
transferred to the company itself, which is obliged to pay the
departing shareholder the actual value of its participatory interest,
which is determined on the basis of the companys net assets.
4. The title to the shares in a ZAO is confirmed by an extract from the
stock register, which each ZAO must hold. An OOO does not hold a
share register; however, all the shareholders must be indicated in
the charter and foundation agreement of the OOO, which are subject
to state registration. Thus, each transfer of shares in an OOO
requires registering the changes in its charter and foundation
agreement.
5. The procedures for making charter capital contributions in a ZAO
and an OOO are different. In short, the charter capital increase in
an OOO is cheaper, shorter and easier since there is no necessity to
register the shares with the Federal Securities Commission.
6. Unlike a ZAO, an OOO can accept from its shareholders so-called
contributions to its property that do not change the number of
shares among the shareholders.
7. The charter of an OOO may provide for the prohibition of sale or any
other disposal of shares to third parties. In such cases, only the
company itself may buy the shares.
Antimonopoly (competition) filing

The Russian Antimonopoly Law establishes requirements of notification or even preliminary approval by the Russian Ministry of
Antimonopoly Policy in certain cases. Thus, for instance, the Russian
Ministry for Antimonopoly Policy must be notified not later than 45
days following the date of state registration of a Russian legal entity,
provided the combined book value of assets of all its founders exceeds
200,000 statutory monthly wages (approximately $600,000 at the
current exchange rate). The notification involves disclosure of certain
documents and information on the founding company and its direct
and indirect owners.
236
Foreign investors doing business in the Russian market usually

choose to create a ZAO in all instances where disagreements between
shareholders may occur or where the number of shareholders is significant. In addition, a ZAO is more attractive for structures designed for
raising capital, while in all other cases (especially where a sole founder
creates a company), an OOO is generally more convenient.
The Law On Foreign Investments in the Russian Federation
nonetheless entitles foreign investors to trade without establishing a
Russian legal entity using representative offices or branches.
Representative offices and branches of a foreign

legal entity
A representative office (abbreviated as RO) is a foreign legal entitys
subdivision in Russia. A representative office represents and protects
the legal entitys interests. Foreign legal entities are entitled to
establish ROs in the Russian Federation only for international operations on behalf of the represented legal entity.
A branch, on the other hand, is a foreign legal entitys separate
subdivision that performs all or some of the functions of the legal
entity, as well as the functions of an RO. The authority of the
subsidiary is broader than that of a representative office.
In accordance with the Law on Foreign Investments, a branch of a
foreign legal entity is created to pursue all the activities in the Russian
Federation that the head organization pursues outside the Russian
Federation.
Neither representative offices nor subsidiaries are considered legal
entities. While representative offices and branches are deemed to be
integral parts of the legal entity that creates them, the parent legal
entity remains responsible for their debts and liabilities. A representative office or a branch is directed by the Head (in other words,
Director) of the representative office/branch who acts on behalf of the
parent company within the authority of the respective power of
attorney.
Formal registration requirements

Effective from 1 January 2004, the registration procedure for Russian
legal entities was simplified by the introduction of a one window
approach and will normally be undertaken within two to two and a half
weeks through local tax authorities, which are responsible for the
registration process. Shelf companies are generally not available and
the incorporation process can take from two to three months.
237
Registration is also required for a branch or representative office of

a foreign legal entity. However, unlike for Russian legal entities, the
registration of a branch or representative office of a foreign legal entity
must be undertaken through several federal and local authorities.
Registration of a branch or representative office of a foreign legal
entity is, in practice, always accompanied by accreditation of a foreign
legal entity through a variety of federal and local bodies. Accreditation
confers certain benefits, including exemption from value added tax
(VAT) on the rental of office space and accommodation for foreign staff.
Although it is not, in theory, a legal requirement, in some parts of
Russia accreditation is effectively compulsory, since the local banks
and administrative authorities may not recognize the office without
this form of registration.
The accreditation fee ranges from $1,000 to $3,500 depending on the
period of accreditation (from one year up to three years for representative offices and from one year up to five years for branches). The
registration and accreditation procedures are fairly complex, but can
normally be completed within two months. If time is of essence, a fasttrack accreditation can be effected for an additional fee of $1,500. This
reduces time for accreditation and registration can be reduced from 60
to 30 working days.
Tax and social fund registration requirements

In addition to the state registration as mentioned above, a Russian
legal entity must register with the tax authorities in the place of its
location as well as in each tax district in which it has a branch, a representative office or real property and transportation vehicles that are
taxable. A foreign legal entity is required to register with the tax
authorities in each tax district in which it carries out business activities. A simplified registration procedure is available for foreign legal
entities that do not carry out activities in Russia, but have property in
Russia or wish to open a rouble investment account with a Russian
bank. A foreign legal entity must notify the tax authorities in each tax
district in which it has a source of income. Notification should also be
sent to the tax office with jurisdiction over the location in which
property belonging to the foreign legal entity is situated.
Separate registration procedures are required for each of the three
Social Funds to meet the liability with respect to the remuneration of
personnel. Entities are also required to register with the State
Statistics Committee. As mentioned above, Russian legal entities may
enjoy a one window registration procedure through the tax authorities, while a branch or representative office of a foreign legal entity
must visit Social Funds offices to get registered there.
238
Legal entities are required to collect receipts in a bank account in

Russia, unless permission to do otherwise has been granted by the
Central Bank of Russia. There are special rules for petty cash operations, which should be observed by Russian legal entities, representative offices and branches of foreign legal entities.
Opening bank accounts to Russian residents

In accordance with new currency legislation, most aspects of which
came into force on 18 June 2004, a foreign legal entity (non-resident)
shall open special bank accounts in the currency of the Russian
Federation (roubles) for itself or its representative office or branch (if
any) (CBR Instruction No. 116-I) for the following types of operations:
1. S-account for purchase from and sale to a resident of bonds on the
domestic market issued on behalf of the Russian Federation,
including settlements and remittance related to transfer of such
bonds;
2. A-account for purchase from and sale to a resident of shares and
investment units of unit investment funds on the domestic market,
including settlements and remittance of such shares and
investment units;
3. O-account for purchase from and sale to a resident of bonds issued
by residents and non-residents on the domestic market, including
settlements and remittance of such bonds, save for bonds issued on
behalf of the Russian Federation;
4. B1-account for settlements and remittance in roubles under loans
from a resident; for receipt from a resident of roubles obtained from
the initial issue of shares and bonds on the domestic market and
from issue of promissory notes on the domestic market to a resident;
5. B2-account for providing a loan to a resident in roubles; for
purchase from and sale to a resident of internal non-issued securities, including settlements and remittance related to transfer of
such securities.
Operations with Russian roubles, which are not listed above, may be
carried out by a non-resident on ordinary rouble accounts. Foreign
currency accounts are opened to non-residents without any limitations.
Russian legal entities (residents) shall open the following types of
special banking accounts in a foreign currency for operations listed
below.
1. R1-account for settlements and remittance under a loan in a
foreign currency from a non-resident; for raising foreign currency
239
from a non-resident received from primary issue of external securities and from issue of external promissory notes to a non-resident;
2. R2-account for settlements and remittance under a loan in a
foreign currency to a non-resident; for purchase of external securities from a non-resident; for sale of external securities to the
benefit of a non-resident.
Operations not listed above may be carried out by a resident on
ordinary rouble accounts. Rouble accounts are open to residents
without any limitations.
Foreign employees
Visa requirements
Foreign personnel must obtain a visa to enter the Russian Federation
(except citizens of most of the former Soviet republics and citizens of
some other countries). Upon registering their visas within three days
of arrival, they may stay freely in the country, provided their visa is
valid. Visa applications must be supported by an invitation from a
Russian individual or legal entity.
Work permits
On the basis of the Law On the Status of Foreigners in the Russian
Federation, effective from 1 November 2002, employers must obtain a
special employment permit if they wish to hire or attract foreigners.
Employees in turn must receive a work permit from the Migration
Authorities before being allowed to work in the Russian Federation. In
this regard, the Russian government adopted a procedure for obtaining
work permits for foreign employees, according to which work permits
must be obtained for all foreign national employees, including highlyskilled specialists and senior managerial staff (CEOs, deputy CEOs,
heads of divisions, including heads of representative offices and
branches). The above requirement applies to foreign nationals who
work for either a representative office/branch or a Russian legal entity.
A procedure for obtaining special employment permits by the
employers is still regulated by the 1993 Presidential Decree to the
extent it does not contradict the Federal Law On the Status of
Foreigners in the Russian Federation. Since the Law took effect,
practice has shown that both employment and work permits are
required not only for foreigners working under employment agreements but also for those providing services under civil law (services)
contracts, engaging in entrepreneurial activity (except in some cases
expressly provided for in the Law).
240
The Law On the Status of Foreigners in the Russian Federation

envisages severe sanctions for breaches of its rules, including
expulsion (deportation) of foreign employees, which may create difficulties or even the impossibility for such foreign nationals of obtaining
another entry visa, while employers are also likely to encounter
complications in the processing of their requests for issuance of further
permits and invitation letters for Russian visas.
Conclusion
While it is usually possible to obtain a work permit and register a
Russian legal entity or a representative office/branch with the various
relevant bodies without professional assistance, it is highly recommended that foreign investors seek out tax and legal advisors to assist
in the process, especially when attempting to determine the type of
Russian legal entity to be registered or to provide foreign personnel to
either a representative office of a foreign legal entity or a Russian legal
entity under the provision of the personnel agreement.
4.4
Business Taxation
Paul Quigley, Deloitte & Touche
Introduction
With growing demand for consumer goods and an abundance of
natural resources, Russia offers some of the best business opportunities in Europe. In the current environment of improving political and
economic stability, it is widely expected that foreign investment will
increase considerably in the next few years.
After the government debt crisis in August 1998 and the subsequent
devaluation of the rouble, many Russian-based businesses benefited
from a reduction in their costs, and the economy as a whole saw a
reduced reliance on imported goods. Furthermore, the country was
blessed by an increase in the price of oil, and since 2000, Russia has
been enjoying a period of significant economic growth. Many foreign
investors, having been badly burned once before, have begun to show
renewed, albeit cautious, interest.
In the past, one of the areas of greatest concern to foreign investors
was the uncertain legal framework in which they had to operate. Much
work has been done in this area over the last 10 years, notably with the
introduction of the Civil Codes of 1994 and 1995 followed by comprehensive laws on joint stock companies, limited liability companies and
bankruptcy. Further legislation is being enacted at a remarkable pace.
Similarly, the tax system has undergone significant developments
since 1991. It is now focused around the development of Russias Tax
Code. As components of the Tax Code are implemented, the problems of
earlier years are being addressed and the system is becoming increasingly compatible with modern business. Part I of the Code, which sets
out the administrative framework of the tax system, came into force on
1 January 1999. This was followed, in Part II, by a revamp of the laws
on personal income tax, VAT, excise and social fund contributions;
these came into force on 1 January 2001. Most recently, the laws on
profits tax and property tax were also codified.
Russia is now able to claim one of the most generous tax regimes in
the industrialized world, with a flat personal income tax rate for
242
residents at 13 per cent and a combined total corporate profits tax

burden at a maximum rate of 24 per cent.
There are, of course, a number of continuing problems. For example,
frequent changes and a lack of clarity of interpretations by the tax
authorities, and certain grey areas in VAT and currency control continue
to present significant challenges. However, we also see that in many areas
of business taxation, the problems today are less often about the failure of
the law to understand concepts, fairness or the substance of transactions,
but are more often about the inappropriate application of the law and
inconsistencies of treatment across the cities and regions of Russia.
The following overview of taxes and related legislation is based on
the laws in effect as of 1 March 2004.
Profits tax
As of 1 January 2002, a new chapter of the Tax Code, Chapter 25, introduced many substantial changes to Russias previous profit tax regime.
The main changes include:
a reduction in the corporate profits tax rate to a maximum of 24 per
cent;
an open list of deductible expenses (an expense that is not expressly
listed as a non-deductible expense is therefore considered to be
deductible);
most tax concessions are abolished (although the loss carry forward
concession will still be applicable with the term extended for 10 years);
taxpayers need to establish an accounting policy for tax purposes
and also implement a system of tax accounting;
the accrual basis of taxation for taxpayers whose average revenue
was in excess of one million roubles per quarter for the previous four
quarters. Those whose average revenue per quarter during the
preceding four quarters was less than this amount, however, may
choose between the accrual or the cash basis of taxation;
dates of income/expense recognition are established for various
types of income and expenses;
the introduction of thin capitalization rules, which affect the
deductibility of interest expenses.
Tax incentives
Although the new Profit Tax Chapter abolishes all tax incentives,
including the Capital Investment Concession, legislation was included
Business Taxation
243
that states that all privileges received by companies as part of their

approved investment agreements with the regional authorities will
continue for the full life of the original agreement. If the life of the
investment agreement was not explicitly defined, the privileges will
continue until the end of the term of recouping the investment project,
but for no more than three years as from the moment of their granting.
Tax rates and timing of payments

Russias standard corporate tax rate has been reduced to 24 per cent.
Additionally, the regional governments have been given the authority
to reduce their portion of the profits tax by up to four per cent. In other
words, the overall profit tax rate may vary from 20 per cent to 24 per
cent depending on the region in which the taxpayer is located.
Profits tax is subject to quarterly filing of returns and monthly
advance payments.
Russian source income for foreign companies

Depending on the type of income, the following withholding tax rates
apply:
10 per cent on income from international freight and the renting of
property involved in international shipping;
15 per cent on dividends received by foreign companies from
Russian legal entities, interest on state and municipal bonds;
20 per cent on royalties, interest (other than that received from state
and municipal bonds), leasing activities (income is determined as the
difference between the gross lease income less the cost of the asset);
20 per cent on all other income subject to withholding tax (with the
exception of income received from the sale of shares in a Russian
entity, which may be subject to withholding tax at the rate of 24 per
cent as explained below).
The sale of shares in Russian entities is only subject to withholding tax
if more than 50 per cent of the assets owned by the entity is comprised
of immovable property. In this case, the shareholder may elect to be
taxed either at the rate of 20 per cent on the gross sales price, or at the
rate of 24 per cent on the difference between the sales price and original
purchase price plus expenses related to the sale. The same rule applies
to the income from the sale of immovable property located in Russia.
Transfer pricing
In general, the tax authorities should accept the price of goods as
stated by the parties to the transaction. However, Russias Tax Code
244
provides for four instances in which the tax authorities are entitled to
verify the prices used:
if the agreement was concluded between related parties;
in the case of barter transactions;
in foreign trade transactions;
if the contract price varies by more than 20 per cent of the market
price for identical (similar) merchandise within a short period of time.
In these instances, the Code empowers the authorities to apply the
market price for tax purposes where the latter varies from the transaction price by more than 20 per cent.
Value added tax

Value added tax (VAT) is charged on the majority of sales of goods and
services realized in Russia and on most imports into Russia. The tax is
payable by all corporate businesses, including offices and branches of
foreign companies and also individual entrepreneurs. However,
companies and individual entrepreneurs can apply for VAT exemption
if their taxable revenues (VAT and sales tax exclusive) remain below
one million roubles for three consecutive months.
Tax rates
The standard VAT rate is 18 per cent. A reduced rate of 10 per cent
applies to certain medicines and medical products, printed periodicals
and books, foodstuffs and childrens goods. A zero per cent rate applies
(amongst other things) to the export of goods and related shipping and
forwarding services as well as passenger transportation when the
destination is outside of Russia.
Place of supply rules

There are specific rules to determine the place of supply for cross-border
works and services. For example, consulting, advertising, information
processing, legal, accounting, engineering, educational, scientific
research and development, and also services related to patents, licences
and the like are subject to VAT if rendered to an entity with a place of
activity in Russia. Payments to a non-registered foreign entity for such
services are subject to withholding at source by a Russian payer.
Exemptions
Major VAT-exempt activities include the lease of office space and
accommodation to accredited foreign representative offices and indi-
Business Taxation
245
viduals; medical services; banking and insurance services; operations

with securities and derivative financial instruments; interest on loans;
and gambling. The import of technological equipment and spare parts
as a contribution to the charter capital is also exempt.
Individual income tax

Personal income tax applies to tax residents on their worldwide income
and to non-residents on their Russian source income. Russian source
income includes any remuneration for duties performed in Russia,
regardless of where or when it is paid. A tax resident is an individual
who has spent no less than 183 days in Russia during a calendar year.
Tax rates
Residents income is subject to a flat rate of 13 per cent except for
specific types of income, which attract different rates. Unless otherwise
protected by a double tax treaty, non-residents are subject to a flat rate
of 30 per cent.
Incomes subject to the different rates include:
dividends: 6 per cent;
winnings, prizes etc: 35 per cent;
interest on loans in excess of established norms: 35 per cent;
insurance payments in excess of established limits: 35 per cent.
Non-residents
The 30 per cent tax rate is applicable to non-residents irrespective of
the nature of their income.
Date of receipt
Income is taxed when received in cash, in kind or by way of material
benefit. Receipt includes power of disposition.
For salaries, the date of income receipt is the last day of the month
for which the salary is accrued.
Deductions
In accordance with the current legislation, taxpayers may deduct 400
roubles from their monthly income if their accumulated annual income
does not exceed 20,000 roubles. An additional deduction in the amount
of 300 roubles can be taken for each dependant within the same limits.
Social deductions include:
246
charitable donations to Russian-financed entities are deductible

within the limits of 25 per cent of the income.
payments for the education of taxpayers and their children (up to
the age of 24) at licensed Russian institutions are deductible up to a
limit of 38,000 roubles per person per year.
payments for medical services made by the taxpayer for him/her and
his/her family are deductible up to a limit of 38,000 roubles per year.
Property deductions
Proceeds from the sale of residential property owned for a period of at
least five years should not be taxable. If the residential property is
owned for less than five years, however, the taxpayer may elect to
either pay tax on the difference between the sale price and one million
roubles or pay tax on the difference between the sale price and the
documented expenses.
Proceeds from the sale of other property owned for a period of at
least three years should not be taxable. If the other property is owned
for less than three years, however, the taxpayer may elect to either pay
tax on the difference between the sale price and 125,000 roubles or pay
tax on the difference between the sale price and the documented
expenses.
The limit on the deduction of expenses on the purchase/construction
of a house or apartment is one million roubles. If this deduction is not
used in full during a particular tax period, its balance may be used in
subsequent tax periods (this deduction is not available in respect of
property purchased from related parties). Interest on a loan to
construct or acquire such property is also deductible.
Non-taxable income
Non-taxable income includes:
state pensions;
most statutory allowances and redundancy payments;
work injury compensation within certain limits;
statutory insurance benefits and certain limited voluntary
insurance benefits;
interest on bank deposits within certain limits.
Taxation of foreign nationals

The only specific provision in the Tax Code relating to the income of
foreign nationals is concerned exclusively with staff of diplomatic or
Business Taxation
247
international bodies. In general, foreigners taxation is governed by

common procedures and depends on residency. Specific exemptions for
certain benefits provided to foreign citizens (including residential
accommodation and company cars) were abolished from 1 January
2001.
Foreigners may only claim benefits under a double tax treaty upon
presentation of proof of residence in the country with which Russia has
concluded the relevant double tax treaty. Such proof must be presented
by the end of the year following the year for which exemption is being
claimed.
Tax agent
For purposes of withholding personal income tax, Russian organizations, entrepreneurs and permanent establishments of foreign
companies are considered as tax agents and are required to calculate,
withhold and remit income tax from payment to individuals. Those
who have received income where the correct amount of tax was
deducted at source and remitted to the budget do not need to file a
Russian tax return within a given calendar year unless they wish to
apply for social or property deductions.
Unified Social Tax (UST)

Russian employers, including Russian representative offices or
branches of foreign legal entities, are obliged to make UST payments
for their employees. The law gives no indication as to where the
employing entity should be located, or where the duties, for which
remuneration is received, should be performed. As such, foreign
entities effecting payments to individuals are considered to be payers
of UST.
Taxable base
The taxable base for UST is calculated for each employee individually,
based on remuneration in cash or in kind. As employees are not payers
of UST, it is only payable by the employer and calculated on a
regressive basis ranging from 35.6 per cent on the first 100,000
roubles of salary to 2 per cent on salary payments in excess of 600,000
roubles.
Exemptions
Exemptions include most statutory allowances, healthcare services
paid by the employer and obligatory insurance payments. There are
also certain exemptions for companies employing disabled staff.
248
Excise tax
Excise tax is imposed on both the import and the manufacture of a list
of goods, the primary categories of which are: alcohol, tobacco, oil, gas,
petrol, jewellery and automobiles. The payers of excise tax are Russian
residing manufacturers and sellers (including those with foreign
investments) of excisable goods, both companies and individual
entrepreneurs, or importers of excisable goods.
Exemptions
Exports of excisable Russian goods outside the CIS countries are free
from excise tax. To receive the exemption, however, a set of documents
proving the export must be presented to the tax authorities.
Property tax
Property tax is a regional tax and is levied at a maximum rate of 2.2
per cent per annum on the property of commercial enterprises and
organizations in Russia, including the property of foreign enterprises
that is located in Russian territory.
Taxable base
The tax is levied on the property of enterprises and organizations.
Exemption is available under a number of double tax treaties, which
provide that movable property should only be taxable in the country of
residency of the owner of the property, provided the property is not
connected with a Russian permanent establishment.
Generally, the taxable base includes most fixed and intangible assets,
inventory, stocks of goods, work-in-progress and unfinished
construction. Land and certain non-productive property are specifically
excluded.
In general, the taxable base is the average net book value (cost less
depreciation) of the property of the enterprise.
Exemptions
A limited number of exemptions are available depending on the type of
organization and the type of property concerned.
Several types of property are exempt from property tax, including
land and property used in nature protection.
Business Taxation
249
Customs duties
A new Customs Code was introduced with effect from 1 January 2004.
Import duties are levied according to the type of goods imported and
their origin. Duties are normally expressed as a percentage of the
value of the goods imported (ad valorem duties). However, they may
also be expressed as a set amount of euros per unit or kilogram (specified duties) or as a combination (the greater of the two).
A new system of tariffs was introduced with effect from 1 January
2001. Prior to 1 January 2001, there were seven ad valorem rates of
duty ranging from zero per cent to 30 per cent. There are now five
rates: 5 per cent, 10 per cent, 15 per cent, 20 per cent and 25 per cent.
Certain goods may also continue to be imported duty free.
Other taxes
Additional taxes, payments and fees may exist from region to region.
Some of these include: the use of subsoil resources; the charge for the
use of the words Russia and Russian Federation in the name of a legal
entity; payments for generating pollution; various licence fees; water
tax; timber duty; hard currency cash purchase tax; and the charge for
street cleaning in populated areas.
4.5
Russian Taxation
Natalia Milchakova, Tax Partner,
PricewaterhouseCoopers, Moscow
The modern Russian tax system has continued to evolve since 1999
when Part I of the Tax Code took effect, with laws and administrative
resolutions dedicated to specific types of tax introducing numerous
procedural and substantive changes to the tax regime. As of January
2004, Russian law establishes the following major business-related
taxes:
Federal taxes
profits tax;
value added tax (VAT);
excise tax;
Unified Social Tax;
customs duties;
Mineral Resources Extraction Tax;
payment for the use of natural resources.
Regional taxes
property tax;
transport tax;
gambling tax.
Local taxes
advertising tax;
land tax.
Individuals are subject to Personal Income Tax.
Russian Taxation
251
Profits tax
Corporations and shareholders are taxed separately. Partnerships are
taxed at the partner level, ie have the benefit of pass-through
taxation. A Russian legal entity is taxed on its worldwide income,
whereas a foreign legal entity is taxed on Russian-source income only.
No tax consolidation within a group of companies is allowed.
All entities are required to maintain, in addition to statutory
accounting records, tax accounting registers.
Companies are generally taxed on income generated from the sale of
goods, work, services or property, or on any other type of non-exempt
income. Sales income and most expenses are generally recognized on
an accrual basis. Most expenses are deductible for tax purposes if they
meet general deductibility rules, ie if they are incurred for the purpose
of deriving income, can be economically justified and are supported by
appropriate documents. There are still some expenses that are wholly
non-deductible or deductible only to a limited extent as established by
government regulations (eg voluntary insurance premiums, entertainment expenses, certain types of advertising expenses etc).
Depreciable assets are classified into 10 groups depending on the
useful life of the asset. For most assets, the company may choose to
apply either the straight-line or the reducing balance method of depreciation. Intangible assets are amortized over the life of the asset.
Tax losses can be carried forward for 10 years; however, the amount
of losses claimed each year cannot reduce the reporting year taxable
profit by more than 30 per cent.
While there are no special tax avoidance provisions in the tax law,
the Tax Code contains transfer pricing provisions. According to these
rules, the tax authorities have the right to adjust the prices of transactions between related parties, barter transactions, foreign trade transactions and on goods (works, services) sold where the prices fluctuated
by more than 20 per cent within a short period of time. If a transaction
is one of the above types, the tax authorities may adjust the price if it
differs from the market price by more than 20 per cent.
In addition, thin capitalization rules apply to transactions between
group companies. According to the thin capitalization rules, a portion
of the interest payable by a Russian organization to a foreign legal
entity owning (directly or indirectly) more than 20 per cent of its
charter capital, may be disallowed as a deduction and reclassified as a
dividend. The thin capitalization rules are only applicable if the
taxpayers outstanding debt owned to the foreign legal entity exceeds
the foreign companys proportionate ownership in the taxpayers
capital by more than three times.
The current profits tax rate is 24 per cent. Regional administrations
have the right to reduce the portion of the profits tax payable to the
252
regional budget by a maximum of 4 per cent. Small enterprises

meeting certain criteria may apply a simplified system of taxation and
accounting, and pay a unified tax on income and a reduced number of
other taxes.
Enterprises, farms and individual entrepreneurs producing agricultural products may be exempt from most taxes by paying a single agricultural tax, subject to certain conditions. Regional authorities have
the right to tax imputed income in their jurisdictions of legal entities
and individual entrepreneurs engaged in certain industries, for
example, retail sales to the general public and transport services,
provided that certain criteria (eg floor space of a trading hall) are met.
The tax rate has been established at 15 per cent. The imputed income
is determined in accordance with a special formula. Payers of the tax
on imputed income are relieved from payment of most other taxes.
Taxation of shareholders
Dividends paid to a resident corporation or a Russian resident individual from Russian subsidiaries are subject to a 6 per cent withholding
tax (9 per cent from 1 January 2005). This tax is withheld at source by
the payer. Russian source dividends are exempt on receipt. No credit for
underlying profits tax is available.
Capital gains of a resident business entity are included in worldwide
income, which is subject to corporate income tax. Losses from the sale
of securities are deductible only to the extent of gains earned on the
same class of securities (although certain exceptions apply for banks,
brokers and other financial institutions).
Losses from the sale of fixed assets may be deducted for profits tax
purposes in equal installments during the remaining economic life of
the asset sold.
A 15 per cent tax is levied on dividends paid to non-resident corporations, unless a double tax treaty provides otherwise. The tax rate applicable to individuals who are treated as non-residents for purposes of
Russian taxation is 30 per cent. However, such amounts may be
exempt from the Russian tax or taxed at a reduced rate pursuant to the
provisions of the respective double tax treaties, provided that certain
conditions are met.
Reorganizations
The tax law does not contain detailed provisions with respect to
corporate reorganizations. The Profits Tax Chapter of the Tax Code
establishes a limited number of rules related to profits tax implications
of reorganizations (eg loss carry forward).
Any transfer of assets in the course of any form of corporate reorganization (including merger, absorption, division, and split-off) is not
Russian Taxation
253
considered a sale for tax purposes. In particular, there is no taxable

gain that arises in the process of re-organization. Such taxable gain
may arise at a later stage, at the moment of a future disposal of assets.
Taxation of foreign legal entities (FLEs)

Foreign corporations are subject to corporate income tax on income
generated from sources in Russia. In general, taxation of business
profits is limited to those attributable to a permanent establishment
(PE). A PE is defined in the Profits Tax Chapter of the Tax Code as a
branch, division, office, bureau, agency, or any other place through
which a foreign legal entity regularly carries out its business activities
in Russia (double taxation treaties may contain different definitions of
a PE). A foreign legal entity also creates a PE if it conducts business
activity in Russia through a dependent agent as provided in the Profits
Tax Chapter of the Tax Code.
Representative offices and branches are subject to tax on substantially the same basis as Russian legal entities. However, in cases when
a foreign legal entity conducts free-of-charge preparatory and/or
auxiliary services for third parties and cannot calculate profit directly,
a deemed profit at 20 per cent of the PEs expenses on such activities
may be used as the tax base.
Income earned by FLEs from sources in the Russian Federation,
which are not related to business activities, is taxed at the source of
payment at the following rates:
15 per cent in relation to dividends;
10 per cent in relation to freight income;
20 per cent in relation to other income from Russian sources,
including royalty and interest.
These rates may be reduced under the terms of the respective double
tax treaties. To enjoy double tax treaties exemptions, the foreign legal
entity must present a confirmation of tax residence in the country of
the double tax treaty to the Russian tax agent.
VAT
Sales of goods (works and services) on the territory of Russia, and
import of goods into Russia, are subject to VAT. Goods are considered to
be sold in Russia if, at the beginning of their transportation or
dispatch, they were located in Russia. The VAT Chapter of the Tax Code
establishes special place of supply rules for different categories of
services. Under these rules, services of a consultancy nature, or
services related to patents, licenses or similar rights or a lease of
254
movable property and some other types of services are regarded as

supplied at the place of activity of the customer. The Tax Code defines
Russia as a place of a companys activity if the company has received
state registration in Russia, or if the companys management or a
permanent executive body or a permanent establishment (if services
are provided through this permanent establishment) is located in
Russia. As for other types of services, the place of supply for VAT
purposes is determined based on the place of activity of the supplier.
Works and services related to movable or immovable property located
in Russia are subject to Russian VAT.
Starting from 1 January 2004, VAT is charged at the rate of 18 per
cent on most goods and services (until 31 December 2003, a 20 per cent
rate was applied). A 10 per cent reduced rate applies to a limited range
of basic food items, childrens goods, medicines and some mass media
products. Export of goods and certain services is zero-rated.
VAT is charged to customers at the applicable rate and paid to the
budget net of input VAT paid on purchases and expenses (including
import VAT paid at customs) provided these purchases and expenses
are incurred in connection with carrying out VAT-able activities
(otherwise, input VAT must be included in the cost of goods (work,
services)). Input VAT is only recoverable if the goods and services are
actually received and the relevant VAT, including import VAT, is paid.
In addition, adherence to VAT-invoicing procedures is critical for input
VAT recovery. Recovery of input VAT with respect to certain business
trip, entertainment and advertising expenses is limited in accordance
with the same limits that apply to the Profits Tax deduction. If sales
are exempt from VAT, as a general rule, the relevant input VAT is not
recoverable but added to the cost of goods (work, services).
Import VAT is applied to the customs value of goods (including
freight, insurance and other costs incurred prior to the customs
border), and increased by any applicable import and excise duties.
Certain medical equipment and contributions of technological
equipment, related components and spare parts to the charter capital
of a Russian legal entity are exempt from import VAT.
If services (goods) subject to Russian VAT are supplied by foreign
entities not registered with the Russian tax authorities, VAT is
collectible via a reverse charge withholding mechanism applied by a
resident agent. Withheld VAT is recoverable by the tax agent as input
tax, provided recovery requirements are met.
VAT exemptions apply to loans in cash, insurance and banking operations (with some exceptions applying to banking operations), circulation of securities, medical equipment (in accordance with the list
approved by the Russian Federation Government) and medical
services, etc.
Russian Taxation
255
Payroll taxes
Currently, the following taxes and contributions are paid by companies
on the employees compensation:
1. Unified Social Tax (UST);
2. Obligatory Pension Insurance Contributions;
3. Social Insurance Contributions for mandatory social insurance
against work-related accidents (Social Insurance Contributions).
Unified Social Tax

Unified Social Tax (UST) is generally levied on total income payable to
Russian and foreign employees and contractors at regressive rates
from 35.6 per cent (for low-income employees) to 2 per cent (applies to
annual incomes in excess of R600,000). UST includes Federal budget,
Medical Funds and Social Fund contributions.
Some changes to the UST Chapter of the Tax Code will be introduced,
effective from 1 January 2005, including reduction of the maximum UST
rate of 35.6 per cent to 26 per cent and changes in the structure of groups
taxed at regressive rates and applicable tax rates for these groups.
The Federal budget portion of the UST is reduced by the amount of
Obligatory Pension Insurance due to the Pension Fund. The portion of
UST attributable to the Social Fund is not applied to contractors.
Obligatory Pension Insurance

Similar to the Unified Social Tax, Obligatory Pension Insurance contributions are accrued on total income payable to employees and
contractors at regressive rates depending on the cumulative remuneration. Remuneration of foreign nationals temporarily residing in
Russia is exempt from such contributions.
Social Insurance Contributions

Social Insurance Contributions rates vary from 0.2 per cent to 8.5 per
cent (depending on the employers activity) of each employees compensation. Income payable to contractors working under civil contracts is
exempt from Social Insurance Contributions provided that accident
insurance is not stipulated in the relevant contracts.
Property tax
Starting from 1 January 2004, the property tax base has significantly
decreased and currently includes only net book value of fixed assets
256
reflected on the taxpayers balance sheet. Intangible assets, inventories and WIP now are excluded from the property tax base of a legal
entity. Foreign legal entities may enjoy tax relief under the relevant
double tax treaties. Foreign legal entities that do not create a PE in
Russia pay property tax only on the net book value of immovable
property located in Russia.
The maximum property tax rate was increased from 2 per cent to 2.2
per cent. The legislative bodies of the regions of the Russian Federation
retain the right to introduce lower property tax rates, as well as grant
the property tax exemptions.
Transport tax
Starting from 1 January 2003, the regional authorities received the
right to introduce a transport tax. The tax is, in most cases, based on
the capacity of a vehicle. The exact tax rate is established by the
regional authorities within the allowed limit.
Advertising tax (will be abolished starting from

1 January 2005)
Advertising tax is established by the local legislative bodies. The tax
rate cannot exceed 5 per cent. In general, advertising expenses
incurred by the company are subject to advertising tax.
Taxation of individuals: Personal income tax

For both Russians and foreigners, tax residence in Russia is determined by the number of days of physical presence in Russia in a
calendar year. For Personal Income Tax (PIT) purposes, an individual
is considered resident if physically present in Russia for 183 days or
more in a calendar year, counting the day of departure but not counting
the day of arrival.
Russian residents are liable to PIT on their total worldwide income
received in a calendar year. Non-residents are taxed on income
received from sources in Russia, which includes income attributable to
work in Russia, rental income from property located in Russia, dividends from Russian organizations etc. Benefits in kind are treated as
taxable income valued at market prices. A number of allowances,
deductions and exemptions are provided by the Tax Code. It is possible
to apply a relevant double tax treaty to exempt certain types of income
from Russian taxation.
Russian Taxation
257
A flat rate of 13 per cent applies to most types of incomes. Different

rates are established for dividends (6 per cent [9 per cent from 1 January
2005]), all types of income received by non-residents in Russia (30 per
cent) and certain income gained from receipt of prizes, insurance
benefits, excessive interest on bank deposits and loans (35 per cent).
PIT should be withheld at source by an employer a tax agent, with
respect to all remuneration paid to individuals (employees and individual contractors, except for those who are duly registered individual
entrepreneurs). Under current rules, the responsibility to be a tax
agent lies with Russian entities, individual entrepreneurs and
permanent establishments of foreign legal entities in Russia. In
addition to withholding obligations, employers are required to provide
information to the tax authorities on income paid and tax withheld,
and to notify the tax authorities about the amounts of income received
by individuals from whom tax could not be withheld.
An individual is required to file his/her annual tax return with the
Russian tax authorities and pay PIT himself/herself in the following
cases:
he/she is self-employed;
he/she received income from which Russian tax was not withheld by
a tax agent;
he/she is a Russian tax resident and received income from sources
outside Russia;
he/she is entitled to, and intends to take, an income tax deduction
provided for under Russian law.
Personal income tax withheld by a tax agent is credited against total
tax liability for the year as stated in the tax declaration.
Dividend income, interest income

on state and municipal bonds
(some of municipal bonds are taxexempt).
15% on dividends received by

FLE from RLE and by RLE from
FLE, interest income on state
and municipal bonds (except for
those that are tax-exempt).
6% on dividends received by
RLEs or individuals Russian tax
residents from RLE. Tax agents
could deduct the amount of
dividends received from RLEs
from the sum of dividends to be
paid to RLEs when the tax base
is calculated.
Rate may be decreased by the

legislative bodies of the RF
constituents to 20% for certain
types of taxpayers.
Maximum aggregate rate of

24%
TAX RATE
Annual filings no later

than 28 March following
the reporting year.
Quarterly filings within

28 days after the end of
the reporting quarter (for
the first 3 quarters);
Annual filings no later

the reporting year.
Quarterly filings within

the reporting quarter (for
the first 3 quarters);
DEADLINE FOR FILING

REPORTS
For some state and municipal bonds 10 days from the end of a month of income payment.
Tax on
dividend
income,
interest
income on
state bonds
For a Russian legal entity (RLE)

profit calculated according to the
Tax Code provisions based on tax
accounting records.
Profits tax
For a Foreign legal entity (FLE)

profit earned from business
activities in the Russian Federation
(RF) through a permanent
establishment is calculated
according to the Profits Tax
Chapter of the Tax Code
provisions based on tax
accounting records using direct
method. The use of indirect
method is allowed only for
preparatory and auxiliary activity in
favour of third parties for free of
charge.
TAX BASE
TAX
Withheld when income is paid by the

entity that pays income, and remitted
to the budget within 10 days from the
payment date.1
FLE
The payments are made within the
deadlines stated for filing of the report.
If the tax is paid monthly on actual

profit earned: the payments are made
not later than the 28th day following
the reporting month. The final annual
payment is made by 28 March
following the reporting year.
RLE
If quarterly payments of the tax with
monthly advance payments are made:
Advance payment not later than the
28th day of the reporting month; final
quarterly/annual payment is made not
later than the deadline for quarterly/
annual filings.
DEADLINE FOR TAX PAYMENT
Appendix A: Taxes and other Obligatory Payments (Except for Customs

Payments) Payable by Russian and Foreign Legal Entities in 2004
258
Value of realized goods (work,

0% exported goods, works
services), including excises (for
and services connected with
goods and mineral raw materials
export of goods; realization of
subject to excise duties);
goods to diplomatic
Market value of goods/services
representative offices;
transferred without charge;
realization of precious metals
Value of imported goods;
etc.;
Expenses on self-construction;
10% some types of
Value of goods (works, services),
foodstuff, goods for children,
used for companys own needs,
books, printed production and
in cases the related expenses are
medical supplies, according to
not profits tax deductible.
the list prescribed by article
164 of Part II of the Tax Code
of Russia;
18% all other goods (works,
services).
Value
added tax
(VAT)
DEADLINE FOR FILING

REPORTS
Payments on a quarterly basis are

made not later than the 20th day of
the month following the reporting
quarter.
Payments on a monthly basis are

made not later than the 20th day of
the month following the reporting
period;
Tax is withheld by the tax agent from

each payment of income to FLE. The
tax must be paid by a tax agent to the
budget simultaneously with the
income payment to FLE (possibly
within 3 days).
Entities with a monthly turnover less than R1,000,000 (approx. $30,000) file returns and pay tax on a quarterly basis.
Filings: no later than the

20th day of the month
following the reporting
month2 (for companies
paying VAT on monthly
basis) or no later than the
20th day of the month
quarter (for companies
paying VAT on a quarterly
basis).
Unless otherwise provided in

Submitted by the person
the applicable double tax treaty: or entity that pays the
income (tax agent) on a
10% on freight income;
quarterly basis 28 days
15% on dividends;
after the end of the
20% on all other kinds of
reporting quarter, for the
income subject to withholding.
reporting year not later
than 28 March.
Income earned by FLEs from

sources in the RF, which are not
related to business activities
performed in the RF through a
permanent establishment.
Withholding
tax on
Russian
sourced
income
TAX RATE
TAX BASE
TAX
Russian Taxation
259
Advertising expenses (VAT

exclusive).
There are several exemptions

available (eg for housing and
infrastructure objects until 1
January 2005, for religious
organizations and organizations for
disabled persons, etc.).
ROs of FLEs must account for

taxable objects according to the
Russian accounting rules.
No more than 5% (established

by local legislative bodies).
No more than 2.2% (the actual

rate in regions are established
by the legislative bodies of RF).
TAX RATE
Advertising tax will be abolished starting from 1 January 2005.
Advertising
tax3
Average annual net book value of

the fixed assets and immovable
property. Land plots, aquatic
facilities, and natural resources
shall not be taxed.
Property
tax
FLEs may enjoy tax relief under

the relevant DTT provisions.
TAX BASE
TAX
By the deadline
established by the local
legislative bodies.
On a quarterly basis within

reporting quarter (during
the first three quarters);
and by the 30th March
year for the annual filing.
DEADLINE FOR FILING

REPORTS
Within the deadline established by

local legislative bodies.
On a quarterly basis within 30 days

after the end of reporting quarter (for
the first 3 quarters) and by the 30th
March following the reporting year
end for annual tax payment.
260
Fixed rates (per unit of

horsepower, gross ton or unit of
transport), which are
differentiated, based on the
engine capacity, gross tonnage
and type of transport.
Engine capacity (based on

horsepower) of vehicles,
depending on the type of
transport vehicles.
Gross tonnage (in gross tons) of
non-wind-propelled waterborne
craft.
Each unit of air transport and
waterborne craft (other than
non-wind-propelled waterborne
craft).
Remuneration, bonuses and other

income paid in cash and in kind,
accrued by an employer in favour
of employees on any basis,
including remuneration paid under
civil law contracts for provision of
works/services, and copyright
agreements.
The tax is calculated for each
employee.
Transport tax
Unified Social
Tax and
pension fund
contributions4
Reporting rules are

established by the
legislative bodies of RF
constituents.
DEADLINE FOR FILING

REPORTS
The final payment is due within 15

days after the quarter (annual) filing
deadline.
Advance monthly payments are made

not later than the 15th day of the next
month; pension funds payments
within the deadline, established for
the receipt of funds for salary
payments, but not later than the 15th
day of the next month.
Established by the legislative bodies

of RF constituents.
Some changes to the UST Chapter of the Tax Code will be introduced effective from 1 January 2005, including reduction of the maximum UST rate
of 35.6% to 26% and changes in the structure of groups taxed at regressive rates and applicable tax rates for these groups.
$18,000) R105,600 + 2% of
the amount, exceeding
R600,000.
The rate depends on the volume Quarterly returns not

of the annual wage/salary of the later than the 20th day
employee:
after the reporting
quarter.
Not more than R100,000
(approx. $3,000) 35.6%;
Annual return not later
From R100,001 to R300,000
(approx. $3,000$9,000)
the reporting year.
R35,600 + 20% of the
amount, exceeding R100,000; In addition, a special
return must be
From R300,001 to R600,000
submitted to the Social
(approx. $9,00018,000)
Insurance Fund by the
R75,600 + 10% of the
amount, exceeding R300,000; 15th day after the end
of the reporting quarter.
More than R600,000 (approx.
The actual rates in regions may

be subject to the maximum 5fold increase/decrease by
legislative bodies of RF
constituents.
TAX RATE
TAX BASE
TAX
Russian Taxation
261
Statutory
accident
insurance
Remuneration, bonuses and other

income paid in cash and in kind,
accrued by an employer in favour
of employees on any basis,
including remuneration paid under
civil law contracts for provision of
works/services, as well as on
license and copyright agreements,
payments in the form of material
assistance and other gratuitous
payments.
Pension tax
Similar to the base for the Unified

Social Tax.
Individual entrepreneurs: income

related to the entrepreneurial
activity, excluding related
expenses.
TAX BASE
TAX
The rate varies depending on

the industry in which the
taxpayer is engaged. For the
majority of industries the rate is
0.2%.
Pension tax amounts decrease

Unified Social Tax that is paid
on contributions to the pension
fund.
Tax rates depend on age and

gender of employees and also
on the amount of tax base.
TAX RATE
Employers: advance monthly

payments within the deadline,
established for the receipt of funds for
salary payments, but not later than
15th day of the next month.
The return must be

Monthly payments within the
submitted to the Social deadline, established for the receipt of
Insurance Fund by the
funds for salary payments (pay day).
15th day after the end of
the reporting quarter.
Annual return not later

the reporting year.
Quarterly returns
(advance payments)
not later than the 20th
day after the reporting
month.
DEADLINE FOR FILING

REPORTS
262
Russian Taxation
263
Appendix B: Double Tax Treaties Concluded

with the Russian Federation
Country
Treaty benefits
available from
Dividends
(%)
Interest
(%)
Royalties
(%)
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
17.
18.
19.
20.
21.
22.
23.
24.
25.
26.
27.
28.
29.
30.
31.
32.
33.
34.
35.
36.
37.
38.
Albania/RF
Armenia/RF
Austria/RF
Azerbaijan/RF
Belarus/RF
Belgium/RF
Bulgaria/RF
Canada/RF
China/RF
Croatia/RF
Cyprus/RF
Czech/RF
Denmark/RF
DPRK/RF
Egypt
Finland/RF
France/RF
Germany/RF
Hungary/RF
Iceland/RF
India/RF
Indonesia/RF
Iran/RF
Ireland/RF
Israel/RF
Italy/RF
Japan/USSR
Kazakhstan/RF
Korea/RF
Kuwait/RF
Kyrgyzstan/RF
Lebanon/RF
Luxembourg/RF
Macedonia/RF
Malaysia/USSR
Mali/RF
Moldova/RF
Mongolia/RF
1 January 1998
1 January 1999
1 January 2003
1 January 1999
1 January 1998
1 January 2001
1 January 1996
1 January 1998
1 January 1998
1 January 1998
1 January 2000
1 January 1998
1 January 1998
1 January 2001
1 January 2001
1 January 2003
1 January 2000
1 January 1997
1 January 1998
1 January 2004
1 January 1999
1 January 2003
1 January 2003
1 January 1996i
1 January 2001
1 January 1999
1 January 1987
1 January 1998
1 January 1996
1 January 2004
1 January 2001
1 January 2001
1 January 1998
1 January 2001
1 January 1989
1 January 2000
1 January 1998
1 January 1998
10
5 vii or 10
5 vii or 15
10
15
10
15
10 vii or 15
10
5 vii or 10
5 vii or 10
10
10
10
10
5 vii or 12
5 vii or 10 or 15
5 vii or 15
10
5 vii or 15
10
15
5 vii or 10
10
10
5 vii or 10
15
10
5 vii or 10
0 vii or 5
10
10
10 vii or 15
10
0 or 15 vii
10 vii or 15
10
10
10
0
0
0 vii or 10
0 vii or 10
0 vii or 10
0 vii or 15
0 vii or 10
0 vii or 10
10
0
0
0
0
0 vii or 15
0
0
0
0
0
0 vii or 10
0 vii or 15
0 vii or 7,5
0
0 vii or 10
10
0 vii or 10
0 vii or 10
0
0
0 vii or 10
0 vii or 5
0
10
0 vii or 15
0 vii or 15
0
0 vii or 10
39.
40.
41.
42.
43.
Morocco/RF
Namibia/RF
Netherlands/RF
New Zealand/RF
Norway/RF
1 January 2000
1 January 2001
1 January 1999
1 January 2004
1 January 2003
5 vii or 10
5 vii or 10
5 vii or 15
15
10
0 vii or 10
0 vii or 10
0
10
0 vii or 10
10
0
0
10
10
0
15
0 vii or 10
10
10
0
10
0
0
15
0
0
0
0
0
10
15
5
0
10
0
0 vii or 10
10
5
10
10
5
0
10
10 vii or 15
0
10
rates in
accordance
with
domestic law
10
5
0
10
0
Construction
site durations
(months)
12
18
12 vii
12
0
12
12
12
18
12
12
12
12
12
6
12 or 18 vii
12
12
12
12
12
3
12
12
12
12
12
12
12 or 24 vii
6
12
12
12
12
6 vii or 12
0
12
24
8
9
12
12
12
Appendix B continued overleaf
264
Appendix B continued
Country
Treaty benefits
available from
Dividends
(%)
Interest
(%)
Royalties
(%)
1 January 1998
1 January 1994
1 January 2003
1 January 2001
1 January 1996
1 January 1998
1 January 1998
1 September 2000
1 January 2001
1 January 2001
1 January 2003
1 January 1996
1 January 1998
1 January 2004
15
10
10 vii or 15
5
15
10
10
10 vii or 15
0 vii or 15
0 vii or 10
0 vii or 10
0 vii or 5
0 vii or 15
0
10
0 vii or 10
15
10
10
0
10
10
10
0
5 vii or 10 or 15
10 vii or 15
5 vii or 15
5 vii or 15
15
1 January 2004
1 January 2000
1 January 2000
1 January 1998ii
1 January 2000
1 January 1994iii
1 January 1996
1 January 1997
1 January 1998
5 vii or 10
10
10
10
5 vii or 15
5 vii or 10
10
10 vii or 15
5 vii or 15
Signed but non-effective treaties

Australia/RF
Status uncleariv
Cuba/RF
Not effective
Ethiopia/RF
Status unclearv
Hellenic Republic/RF
Not effective
Lithuania/RF
Not effective
Malta/RF
Not effective
Mauritius/RF
Status unclearv
Oman/RF
Not effective
Argentine/RF
Not effective
Estonia/RF
Not effective
Georgia/RF
Not effective
Singapore/RF
Not effective
Thailand/RF
Not effective
5 vii or 15
5 vii or 15
5
5 vii or 10
5 vii or 10
5 vii or 10
5 vii or 10
5 vii or 10
N/Avi
5 vii or 10
10
N/Avi
15
44.
45.
46.
47.
48.
49.
50.
51.
Philippines/RF
Poland/RF
Portugal/RF
Qatar/RF
Romania/RF
Slovakia/RF
Slovenia/RF
South Africa/RF
52.
53.
54.
55.
56.
Spain/RF
Sri Lanka/RF
Sweden/RF
Switzerland/RF
Syria/RF
57.
58.
59.
60.
61.
62.
63.
64.
65.
Tajikistan/RF
Turkey/RF
Turkmenistan/RF
UK/RF
Ukraine/RF
USA/RF
Uzbekistan/RF
Vietnam/RF
Yugoslavia/RF
i
ii
iii
iv
0 vii or 5
5
0 vii or 10
10
0
0
0 or 5 or 10 vii
0
0 vii or 10
4.5 vii or 13.5
or 18
0 vii or 10
0
0 vii or 10
10
5
5
0
0
0 vii or 10
10
0
0
0 vii or 10
0
10
15
10
10
10
0 vii or 10
0 vii or 5
7
0 vii or 10
0
0
0
N/Avi
0 vii or 10
0 vii or 10
N/Avi
0 vii or 10
10
5
15
7
5 vii or 10
0
0
5
N/Avi
10
5
N/Avi
15
Construction
site durations
(months)
183 days
12 or 24 vii
12
6
12
12
12
12
12
6
12
12
6
24
18
12
12
12
18
12
6
18
12
12
9
9
9
6
12
9
9
9
6
In Ireland tax relief is available from 1/01/96 or 6/04/96 (depending on the tax).
In the UK tax relief is available from 1/04/98 or 6/04/98 (depending on the tax).
In the USA and RF tax relief is available from 1/01/94 or 1/02/94 (depending on the tax).
The Double Tax Treaty with Australia was ratified by the Russian Federation on 9 December 2003,
however, the Treaty has not been officially published yet.
v There is no information whether the treaty is concluded (awaited from the RF Ministry of Foreign Affairs).
vi Details of the treaty are not available (awaited from the RF Ministry of Foreign Affairs).
vii Certain requirements/conditions are provided in the DTT for application of the rate/definition of
construction site duration.
4.6

Andrei Elinson, Deloitte & Touche
Current state of the auditing profession in Russia

History
The auditing profession has a relatively short history in the Russian
Federation. As with other professions that are part of the economic
infrastructure of a market-oriented society, it simply did not exist as
such prior to the start of the political and economic market reforms in
the mid-1980s. In a state-planned and managed economy, where the
only owner and user of resources was the State itself, the only relatively similar profession that existed was that of the state controllers
who worked for various governmental ministries, as well as the higherlevel controllers working for the Ministry of Finance and specifically, in
the area of foreign trade, the Ministry of Foreign Trade.
With the introduction of market reforms prior to the dissolution of
the Soviet Union, for the first time the concept of auditing was introduced. Its inception followed the first Governmental Decrees of 1987
and 1988 on Joint Venture Activities in the USSR. The first audit firm
ever to commence work in the country was AO Inaudit a state-owned
and controlled company, which was the sole empowered auditor
working in the market.
The actual creation of the profession started later, during the 1980s
to early 1990s, when the largest international accounting and auditing
firms (the Big Six) began to enter the market, and the newly-obtained
economic freedom enjoyed by entities created the need and demand for
consulting and accounting services.
In the early 1990s the auditing profession was not governed by any
specific legislation, although many attempts were made to create and
introduce such laws. Various professional unions and associations were
created. The first attempts were made to adopt auditing standards at
least at firm or association levels. The first certification procedures
were put in place by the most prominent professional associations and
the local authorities. The process was chaotic until at last, in 1993, a
266
Presidential Decree was issued enforcing The Temporary Regulations

on Auditing Activities in the Russian Federation (the Decree). This
decree was subsequently superseded by the Law on Auditing Activity
in 2001.
Legislation
The Decree attempted to fill the legislative vacuum that existed at the
time, and served its purpose in pulling together the various practices
that existed, both international and domestic. It established the basic
principles of independence and created a structure for the certification
and licensing process. The basic feature of the Decree was that it
empowered the Government to regulate the profession through its
bodies (such as the Ministry of Finance). The regulation of bank audits
was then under the separate responsibility of the Central Bank of the
Russian Federation.
The 1993 Decree also established the Presidential Audit
Commission (PAC). The PAC has so far set 34 Russian Standards on
Auditing (RSA).
In 1994, the Government issued Regulation #482, On the Approval
of the Supervision of Auditing Activities, to initially form three audit
industry licensing bodies, known as the Central Certification
Licensing Auditing Commissions (Tsalak), covering general, banking
and insurance, as well as budget funded and exchange organizations.
In the summer of 1996, following a government reorganization, the two
non-banking Tsalak bodies merged to form a single Tsalak (MinFin
Tsalak), which was comprised of 25 representatives, including representatives from the Ministry of Finance, the PAC, the Central Bank,
and other governmental and professional bodies.
The Tsalaks of both the Ministry of Finance and the Central Bank
had the responsibility for audit examinations, attestation and
licensing issues. The PAC was responsible for professional standards
insofar as that it issued recommendations on exams and, more importantly, introduced auditing standards.
In May 1997, the PAC, the Ministry of Finance and the Financial
Scientific Research Institute published a collection of 11 rules (standards) for auditing activity and a list of terms and definitions thereto.
However, in the absence of any auditing law, some auditing firms
disputed the compulsory nature of these rules. Some clarification on
the matter was provided by Resolution #472 of the Russian
Government, dated 27 April 1999, On the Licensing of Some Types of
Auditing Activity in the Russian Federation, which established that
the quality of audits should correspond to the standards approved by
the PAC. By the end of 2000, work on Russian auditing standards
within the framework of the Action Programme for the Audit of
267
Financial Statements of Economic Entities Using Internationallybased Auditing Standards in the Period 1998 to 1999, adopted in accordance with an assignment of the Russian Government dated 4 January
1998, was essentially complete.
In October 2000, with the participation of the ICAR, the Big Five
and several major Russian auditing firms, the official Russian translation of the International Auditing Standards and Ethics Code of the
IFAC was first published, and the second official edition of the Code,
including some new documents, was published in August 2001. The two
publications were of a referential nature, and were to be used in the
process of developing new auditing standards.
Government Regulation #1355, dated 7 December 1994 (amended
by Government Regulation #408, dated 15 April 1995), originally
established the criteria for economic entities subject to a compulsory
annual audit as follows:
open joint stock companies; banks and other credit organizations;
insurance companies and mutual insurers; commodities and stock
exchanges; investment institutions;
extra-budgetary funds that collect mandatory contributions; charity
and (non-investment) funds that collect voluntary contributions;
companies with foreign-owned capital;
other economic entities if total annual revenues and assets exceed
specified amounts.
The aforementioned decrees and pronouncements of the Central Bank
and Presidential Commission have served as the legislative basis for
the profession to date.
Provisions elaborating on the auditors functions during the audit of
certain types of entities were included in the laws on joint stock
companies and limited liability companies. The Federal Law On Joint
Stock Companies, dated 26 December 1995, established that an
auditor may have access to statutory documents of a joint stock
company, assess property contributed in payment for shares and other
securities, check the correspondence of the companys net asset value
to the size of its share capital, issue an opinion based on the results of
the annual audit of the company and require that an extraordinary
meeting of shareholders or the board of directors be convened. Similar
functions and authorities were granted to auditors by the Federal Law
On Limited Liability Companies, dated 8 February 1998. An audit
opinion, confirming the financial statements of an entity subject to an
obligatory audit in accordance with the Federal Law On Accounting,
dated 21 November 1996, became an integral part of the financial
statements.
268
Current developments in the regulatory environment

As time passed, business communities, as well as the auditing
profession, realized that the existing legislative infrastructure was not
sufficient to protect the public and States interests, nor to protect the
auditing profession. The process of instituting a comprehensive audit
law was embarked upon. In the summer of 2001, following a long
discussion, with the participation of the Russian auditing community,
the Federal Law On Auditing Activity was finally adopted and took
effect on 9 September of the same year.
The law stipulates that the following entities should be subject to
obligatory audit:
open joint stock companies;
credit institutions, insurance and mutual insurance companies,
commodities and stock exchanges, investment funds, state extrabudgetary funds that collect mandatory contributions;
entities or individual entrepreneurs whose annual revenue exceeds
500,000 times the minimum statutory monthly wage, or whose
balance sheet assets at the end of the reporting year exceed 200,000
times the minimum statutory monthly wage;
state unitary enterprises if their performance falls within the above
limits.
Where before the adoption of the Law audit certificates were issued for
a limited period, now a certificate of qualification is issued to auditors
who have successfully passed the qualification exam without any time
limitation. However, auditors are still obliged to undergo professional
training each calendar year.
The Law established that an authorized federal body should
regulate auditing activity, and the Russian Government assigned this
function to the Department of Organization of Auditing Activity of the
Ministry of Finance. In order to achieve a balance between state regulation of auditing activity and the ability of the auditing community to
influence the auditing market, an Auditing Activity Board was established under the above body. The Board, as well as representatives of
the federal executive bodies, other state authorities and the Bank of
Russia, also includes representatives from seven professional auditing
associations accredited with the Board, including: the Institute of
Professional Auditors of Russia (member of IFAC), the Russian
Auditors Collegium, the National Federation of Consultants and
Auditors, and the Auditing Chamber of Russia, etc.
In accordance with the Law, the Government was also obliged to
develop and approve national auditing standards. With the participation
269
of the above Board, the following federal auditing rules

(standards) were developed and approved by Resolution #696, dated 23
September 2002:
Rule #1: Objective and Main Principles of an Audit of Financial
Statements established that the objective of an audit is to express
an opinion on the financial statements of the audited entity and the
compliance of its accounting procedures with the legislation of
the Russian Federation. The auditor should express an opinion on the
reliability of the financial (accounting) statements in all material
respects.
Rule #2: Audit Documentation Maintenance stated that the
auditing firm or individual auditor should document all the information that is important in terms of providing evidence supporting
the auditors opinion, as well as evidence that the audit has been
performed in accordance with the federal rules (standards) of
auditing activities. Working documents can be in the form of data
recorded on paper, on film, in an electronic file, or in other formats.
Rule #3: Audit Planning, based on International Auditing
Standards, established unified requirements for the planning of an
audit of the financial (accounting) statements, which should be
applied primarily to repeat audits of the audited entity (ie not the
first year that the auditor has audited the entity). According to this
rule, audit planning involves, in particular, the development of a
high-level strategy and a detailed approach to the expected nature,
timing and scope of audit procedures.
Rule #4: Audit Materiality, also based on International Auditing
Standards, established unified requirements in respect of the materiality concept and its connection to audit risk. It requires that the
auditor use professional judgment in determining materiality. In
developing an audit plan, the auditor should set an acceptable materiality level to ensure the detection of material misstatements (on
quantitative grounds). However, account should be taken of both the
value (quantity) and the nature (quality) of misstatements.
Rule #5: Audit Evidence established, in particular, that audit
evidence should be obtained through a series of tests of internal
controls and substantive procedures. In certain situations, evidence
can be obtained exclusively by performing substantive procedures.
According to this Standard, audit evidence includes the information
received by the auditor during the audit and the results of their
analysis of this information, and forms the basis of the auditors
opinion. Audit evidence includes, in particular, the source documents and accounting records that underlie the financial
270
(accounting) statements, as well as written representations of the

audited entitys authorized employees and information received
from various sources (third parties).
Rule #6: Auditors Report on Financial (Accounting) Statements.
According to this rule, an auditors report is an official document
intended for the users of the financial (accounting) statements of the
audited entity, prepared in accordance with this rule and containing
the opinion of the audit company or individual auditor. This report
should be expressed in a prescribed format, and should comment on
the reliability of the financial (accounting) statements of the audited
entity, as well as the entitys compliance with the accounting laws of
the Russian Federation. The reliability of the financial statements
refers to the accuracy of the data contained within the financial
(accounting) statements, which enables the users of the statements to
draw correct conclusions as to the performance, financial position and
property status of the audited entities and make reasonable decisions
based on these conclusions. In order to assess the degree of compliance
of the financial (accounting) statements with the legislation of the
Russian Federation, the auditor should establish the tolerable limits
of deviation by determining the materiality of the accounting records
and financial statements data for the purposes of the audit, in accordance with federal Rule #4 Audit Materiality. At present, the Board
continues to develop other rules (standards) on auditing activity, and
professional auditing organizations have begun to develop rules to
guarantee the quality of audits performed by their members.
Rule #7: Internal Control of the Quality of the Audit, based on
International Accounting Standards, established unified requirements for audit internal control of quality. It requires that measures
be taken both at the overall level of the audit firm itself and on individual projects. These measures include professional requirements,
professional competence, challenging tasks, recommendations, and
monitoring the efficiency of internal control procedures.
Rule #8: Auditors Risk Estimation and Internal Control of the
Audited Entity, based on International Accounting Standards,
required that the auditor achieve understanding of the accounting
and internal control systems, and of audit risk and its components:
inherent risk, control risk and detection risk. According to this rule
the auditor should obtain sufficient understanding of the accounting
and internal control systems to plan the audit. The auditor should
use professional judgment to assess audit risk and to design audit
procedures to ensure that it is reduced to an acceptably low level.
Rule #9: Related Parties, based on International Accounting
Standards, stipulated that the auditor should perform audit
271
procedures designed to obtain sufficient appropriate audit evidence

regarding the identification and disclosure of related parties by
management, and the effect of related-party transactions that are
material to the financial statements. In this rule the term related
parties means natural and legal persons who have the ability to
impact upon the activity of legal and/or natural persons engaged in
business activity. However, an audit cannot be expected to detect all
related-party transactions.
Rule #10: Subsequent Events, based on International Accounting
Standards, established standards and provided guidance on the
auditors responsibility regarding subsequent events. In this rule,
the term subsequent events is used to refer to both events occurring
between period end and the date of the auditors report, and facts
discovered after the date of the auditors report.
Rule #11: Going Concern, based on International Accounting
Standards, set standards on the auditors responsibilities, including
consideration of managements assessment of the entitys ability to
continue as a going concern. Under the going concern assumption,
an entity is ordinarily viewed as continuing in business for the foreseeable future with neither the intention nor the necessity of liquidation, cessation of trading or seeking protection from creditors
pursuant to laws or regulations.
Additionally the Code of Audit Ethics, which is based on International
Accounting Standards, was established in August 2003. It endorses the
concepts of objectivity, integrity and professional competence, and is
applicable to all professional auditors.
Conclusion
In conditions where most Russian auditors focus their attention on
tax-related issues, one must also take steps to ensure audit quality,
auditor independence and financial liability in case of negligence, recklessness or fraud.
In the present Russian audit environment, an audit infrastructure
is required to ensure a high quality statutory audit function, and the
issuance of correct and credible financial statements by all that
practice in the profession is in the process of active development. While
some firms that practice in the profession do perform high-quality
audits, others do not. Such an infrastructure could be broadly broken
down into the following categories:
control over the quality of audit services using the principles established by the respective International Auditing Standard;
rules on audit firms and mutual recognition;
272
unification of the currently disconnected professional auditing and

accounting associations;
completion of the development of professional standards on
auditing, based on International Auditing Standards;
ethical rules and independence, based on the IFACs ethics code;
disciplinary procedures and sanctions infrastructure;
liability regime.
Accounting standards in the Russian Federation

The Russian Federations move to a market economy has also necessitated a change in the standards of accounting for the financial position
and results of operations of Russian enterprises.
While the Russian Accounting Standards (RAS) have gone through
reform over the years, the major reform needed for the standards to be
in full compliance with International Accounting Standards (IFRS)
has fallen short.
The Ministry of Finance of the Russian Federation has been given
the responsibility of instituting reform of the RAS. This holds true for
all organizations, except those that are required to report to the
Central Bank of the Russian Federation, which have their own rules
for reporting.
Since 1998 the Ministry of Finance has increasingly instituted revisions in an effort to account for transactions under more internationally accepted methods. For example, accounting for revenue under
the accrual method has been introduced and accruing expenses
incurred but not paid is now required in certain situations. In
particular, provisions on accounting (termed PBU) have been issued.
These PBUs include the following topics: Financial Statement of
Organization; Financial Investment Accounting; Income Tax Accounting;
Expenditure on Research and Development and Technological Works
Accounting; Activity Terminated Accounting; Conditional Facts of
Economic Activity; Inventory Accounting; Fixed Assets Accounting;
Affiliated Parties; Organizations Income; Organizations Expense;
Organizations Accounting Policy; Subsequent Events; Loans and Credits
Accounting; Intangible Assets Accounting; State Financing Accounting;
Segment Information; Accounting of Assets and Liabilities valued in
foreign currency; Accounting for Construction in Progress.
Nevertheless, even with the issuance of these accounting policies,
fundamental differences still remain. While the PBUs may be similar
to IFRS, they are not IFRS, and therefore important differences
remain.
273
Despite the stated intention of the Chairman of the Russian

Government to transfer to IFRS by 2004, there are still many differences between IFRS and RAS. GAAP 2000 and 2001 surveys of
National Accounting Rules in 53 countries showed the existence of
multiple variances between national accounting rules and IFRS in a
number of European countries, including in more than 42 accounting
areas in Russia.
Russian accounting may differ from IFRS because of the absence of
specific Russian rules on recognition and measurement. Some of the
more significant areas include:
the distinction between acquisition and unification of interests in
business combination situations;
provisions in the context of business combinations accounted for as
acquisitions;
consolidation of special-purpose entities;
accounting for associate companies;
the restatement of financial statements of companies reporting in
the currency of a hyperinflationary economy in terms of the
measuring unit currency at the balance sheet date;
the translation of the financial statements of hyperinflationary
subsidiaries;
impairment of assets;
the recognition of operating lease incentives;
restatement of financial statements;
accounting for changes in enacted tax rates for deferred tax;
accounting for an issuers financial instruments.
It is unfortunate that RAS have not moved closer to IFRS. As a result,
many companies, particularly those that are interested in obtaining
Western investment, have the double burden of preparing their
accounts under both methods, one to fulfill legal requirements and one
to attract the interest of Western investors. Moreover, with the
adoption of Chapter 25 of the new Tax Code, Russian companies also
need to keep tax accounts.
Conclusion
Whilst many would say that reform has already occurred, one only
needs to compare company accounts prepared under RAS to those
prepared under IFRS to see that more reforms are needed. Many
274
international organizations are anxious for these reforms to be carried

out. At present, it is difficult to estimate when these reforms will take
place. In the meantime, in order for external investors to be able to
properly evaluate the financial position and results of operations of
enterprises, credible financial statements prepared under IFRS (or
another internationally-accepted method, ie US GAAP) must be
requested and obtained.
4.7
New Russian Customs

Legislation
Alexander Dragunov, Director, Customs
Practice, PricewaterhouseCoopers
The enactment of the new Russian Federation Customs Code, which

took effect on 1 January 2004, resulted from the objective need to bring
customs legislation into line with the Constitution of the Russian
Federation and with a number of important federal laws that were
passed after the old version of the Customs Code had come into force,
as well as the need to account for international practice, Russias
growing foreign trade turnover, and the creation of an attractive
investment climate in the country. On the whole, as statute law, the old
Customs Code did not necessarily create any particular difficulties for
entities engaged in foreign trade.
The customs value is determined in line with GATT/WTO principles
and is generally equivalent to the DAF/Russian border transaction
price of the goods concerned. Classification of customs codes follows the
international Harmonized Commodity Description and Coding
System.
From a real business perspective, the greatest achievement of the
new Customs Code is that, effective 1 January 2004, it has substantially simplified the procedure for appealing the unlawful actions (or
inaction) of the customs authorities through the arbitration courts.
Under the old customs rules, before filing with an arbitration court, the
appeal first had to be submitted to the superior customs body, and only
if the claimant remains unsatisfied with the decision of the superior
customs body could a secondary appeal be filed directly with the arbitration court. This procedure was excessively harsh on business, since
it was virtually impossible to resolve disputes with customs quickly
and with minimal financial losses. However, it is now possible to file
suit in court immediately, thus bypassing the lengthy process of having
a problem reviewed in the depths of customs bureaucracy. Moreover,
the new procedural options available for defending ones rights in court
276
open up a wider range of possibilities for identifying the most efficient

means of responding to a given scenario. Previously, in cases where the
customs authorities took unlawful actions with respect to a business,
the company was forced to exclude the affected goods or exacted funds
from its turnover for a whole six months. However, it now seems likely
that this will cease. In addition to allowing the direct filing of lawsuits
in arbitration courts, the new Customs Code also permits the claimant
to simultaneously petition the court to bar the customs authorities
from exacting funds.
The RF Federal Customs Service (former State Customs
Committee) has been divested of its powers to issue legal acts. From
now on, all major legal acts regulating customs affairs will be issued
directly by the Ministry of Economic Developments and Trade and the
government. The Ministry of Finance will dictate policy on customs
payments, and customs valuation of goods and means of transport.
As of 1 January 2004, an importer will be able to clear its goods at
any customs office without requesting additional authorization to do so.
The new Customs Code provides many opportunities for applying
simplified customs clearance procedures. If an entity engaged in
foreign trade is not in continued breach of customs rules and has
engaged in foreign trade for at least three years, it may declare goods
by submitting documents and then submitting a customs cargo declaration within 45 days. It may also apply the periodic declaration
procedure by submitting one declaration for goods imported in several
shipments over a certain period of time. Other options are now also
available for reducing logistics costs.
Particular attention should be paid to new provisions on the
temporary storage of goods. The old Customs Code mandated that
goods could be stored and customs clearance performed only at
temporary storage warehouses. Many importers had to pay expensive
fees for temporary warehouse storage. The new Code now permits the
storage of such goods at the recipients own warehouse. Moreover, the
given warehouse does not have to be a customs temporary storage
warehouse, equipped according to strict customs rules. In addition, it
will now be sufficient to merely submit a substantiated application to
the customs office to have the storage period extended by two to four
months.
At the same time, however, one should not get the impression that
importers now have unlimited freedom of choice as regards the place of
customs clearance. For example, depending on the means of transport
used to perform the international carriage of goods, or for goods
frequently found in breach of customs rules, the customs authorities
may establish a list of specific customs offices at which such goods
must be cleared. Thus, the current system of specialized customs
offices will continue to exist.
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In addition, as regards declaring goods, another aspect worthy of

mention are so-called technical errors that frequently turn up unintentionally in customs declarations. From now on, all errors detected
during customs control that have no effect on customs payments made
shall not be deemed an obstacle to the release of goods. Moreover, no
charges may be brought for customs offences if such errors are
detected.
Under the simplified procedure for confirming the country of origin
of goods, a certificate of origin must be submitted only in those cases
when the goods in question qualify for customs benefits in applying
import customs duty rates. But, even the lack of such a certificate does
not entitle the customs authorities to apply the base duty rate,
increased by two.
There have been positive changes concerning release of goods as
well. The customs authorities will have only three days to carry out an
inspection, after which the goods must be released. Moreover,
regarding acceptance of customs declarations, the new Customs Code
does away with the requirement to prove that customs payments have
been made. For the purposes of releasing goods, it will be necessary
either to have funds available on the appropriate accounts or to have
submitted a guarantee that customs payments will be made. Given all
the specific features of customs procedures, one should bear in mind
that, aside from the general grounds for releasing goods, there are
those that are merely implied for different regimes. For example,
special authorization must be obtained to place goods under the
customs processing regime.
Regulation of customs regimes has also undergone a number of
changes. The most positive changes concern customs regimes with an
economic impact. Customs processing regimes make it significantly
easier to repair goods, while the customs warehouse regime permits
the sale of goods directly from the warehouse. Special regimes for
means of transport are also provided.
The temporary import customs regime deserves particular attention.
For fixed production assets, it is now permitted to use temporary
import for 34 months and make partial customs payments in the
amount of 3 per cent per month. This is a unique procedure for making
payments: the taxpayer not only makes its customs payments in
installments, but such installment payments will be interest-free. At
the end of the temporary import period, the goods are automatically
recognized as released for home use.
Effective 1 January 2004, the procedure for making customs
payments has come under the purview of the new Customs Code.
However, taxes and duties are set in accordance with the rules of the
Tax Code. Interestingly, the new Code has established a number of
innovations not envisioned under tax legislation. For example, it sets a
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minimum value for imported goods (R5,000) that will not be subject to
customs duties and taxes provided that such deliveries occur no more
than once per week. In contrast to the Tax Code, the new Customs Code
establishes new rules for determining the taxable base for goods being
transferred when calculating value added tax, which is equal to the
customs value only. Also, businesses do not need to make customs
payments where a loss of goods occurred as a result of natural operational wear and tear. The new Customs Code also sets its own rules for
calculating interest for installment payments or deferments of customs
payments, but does not establish any fixed fee for customs clearance.
These innovations in customs legislation probably represent the legal
manifestation of the governments efforts to reduce the tax burden.
One more important innovation introduced by the new Customs Code
is a statute of limitations for effecting customs payments, namely one
year from the date the taxpayers liability for customs payments first
arose.
However, the new Customs Code has expanded the list of customs
operations that may require providing security for customs payments.
All goods not subject to customs payments (due to tax exemptions or
preferential customs regimes, or goods released under simplified
procedures) will be considered foreign goods. It is precisely in these
cases that provision of security for customs payments could be
required. Given a choice of the type of security provided, importers
should bear in mind that all forms of security are regulated by the
norms of civil law, where relations between parties are based on
equality, autonomy, and independence. This means that the customs
authorities may not accept any type of security, and, in particular, this
concerns guarantees and pledges of property. Therefore, analyzing
which form of security to use will take time, and the final choice must
be agreed upon with the relevant customs post. However, security is
not now mandatory. A security is required only if the customs office has
serious and valid grounds to believe that the importers obligations will
not be met. Such grounds may include the existence of unpaid debts for
customs payments or frequent breach of customs rules, as well as
bankruptcy proceedings with respect to the importer, etc.
The new Customs Code limits the period during which goods may be
under customs supervision after their release. According to the general
rule, all goods that lose their status while under customs supervision
may be subject to subsequent customs control only within the course of
one year. This rule does not apply to those goods that will be placed
under customs regimes that are under the continuous supervision of
the customs authorities; for example, the placement of goods in a
customs warehouse, where the goods are monitored throughout the
entire storage period. The new Customs Code does not limit the timeframe for performing customs supervision after the release of goods
279
with customs payment exemptions. An example of such goods would be

the importation of equipment as a contribution to a companys charter
(joint) capital, or goods imported as humanitarian aid.
The real potential stumbling block concerns how the new Customs
Code will actually be applied in practice by various customs authorities. Certainly, as enacted, the new Customs Code is aimed at making
customs procedures as transparent and simple as possible, while
painless and fast. However, all the progressive innovations of the new
Customs Code notwithstanding, only actual practice can answer the
major questions now being raised by all parties involved in customs
relations. That said, the time has finally come when all parties
involved in customs relations have a real opportunity to form a new,
civilized customs practice.
Here we list the most significant changes in Russian customs
legislation:
The RF Federal Customs Service was divested of its powers to issue
legal acts.
It is now possible to directly file claims with a court of law against
actions (or inaction) of customs authorities and officials.
Customs legislation provides for a comprehensive list of documents
to be submitted when applying for customs clearance.
In cases of conditional release, it may be required to put up security
for the period of conditional release (such as goods as collateral, a
bank guarantee, cash deposit or surety).
The maximum time period for customs inspection was reduced from
10 to 3 days.
The customs authorities are prohibited from refusing to accept a
declaration that contains inaccurate information, but which has no
impact on the defrayal of customs payments or on the application of
foreign trade restrictions.
The customs clearance of goods may now be carried out through any
customs office. The old Customs Code had stipulated that the place of
customs clearance should be the customs office in the region where
the specific entity, or its structural subdivision, was registered.
The new Customs Code provides urgent customs clearance for
perishable goods, express cargoes, media materials, and other categories of goods.
Following the release of goods, the customs authorities are entitled
to verify the reliability of information declared at customs clearance
within one year from the date when the goods in question are
released from customs control.
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Goods that qualify as fixed assets may be temporarily imported for

34 months with periodic customs payments. Such goods are recognized as released for free circulation when the amount of periodic
customs payments reaches the total amount of customs duties
payable when the goods are imported for free circulation. No
interest is charged in this case.
Foreign individuals may temporarily import goods that are neither
for production nor for other commercial activity, but for personal
use, and are intended to be re-exported, without payment of duties.
Individuals may import goods for their personal use in accordance
with the regulations set forth in the Customs Code. Currently, individuals may bring in goods up to a value of $2,000 (subject to certain
conditions).
Cultural valuables are imported by individuals duty free.
Part Five
Business Development:
Operating an Enterprise
5.1
The Property Regime in

Russia
CMS Cameron McKenna
Introduction
The Russian Constitution of 1993 proclaims a right to hold land in
private ownership. This is supported by the Civil Code of 1996, but
Chapter 17 of the Civil Code, which was intended to establish a
framework for transactions in land, was not brought into effect until 29
October 2001 when the new Land Code of the Russian Federation came
into force. On 30 October 2001, almost 84 years to the day after the
October Revolution of 1917, Russia passed a federal law overturning
one of the remaining legacies of the USSR: state ownership of land. The
new Land Code at long last permits private ownership of commercial
land and, together with Chapter 17 of the Civil Code that now comes
into effect, governs transactions in land. In general, foreign individuals
and companies are allowed to buy and sell commercial land except in
certain border and other designated areas. Agricultural land, however,
has been excluded from the provisions of the Land Code and is dealt
with in a law on agricultural land dated 24 July 2002. Perhaps the
greatest practical significance of the Land Code is that it applies to the
whole of the Russian Federation and the existing patchwork of
regional land legislation is to be amended to bring it into line with this
federal law. The Land Code has therefore removed the many discrepancies and inconsistencies that have appeared between regional and
federal land law in the last few years, as certain regions had forged
ahead with their own land law reform programmes.
Land
Article 9 of the Constitution provides that land and other natural
resources may be held in private, state, municipal or certain other
forms of ownership.
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Business Development: Operating an Enterprise
The Land Code divides land into several categories on the basis of a
designated prescribed use. These are as follows:
agricultural land;
land for housing;
commercial land for use by industrial enterprises, power companies,
communications companies etc;
land that is situated beneath an object which is itself specially
protected (eg nature parks);
forestry land;
water-front land; and
reserve land (land which is owned by the State, is not used for
commercial purposes, and which can be transferred to any of the
other categories in effect, a miscellaneous grouping).
It is important, therefore, for a potential purchaser to check the
prescribed use of any land before buying it. The prescribed use should
be stated in all title documents, any agreement for use of the land and
all registration documents. Each category has different conditions for
usage and the Land Code requires that each plot of land is used and
exploited only in accordance with the category in which it is designated. So, for example, it will not be permissible to build a factory on
agricultural land. It should be noted, however, that in such a situation
an application can be made to the relevant State authority to have the
prescribed use of a particular plot of land changed.
Many of the subjects of the Federation, (namely the 89 regions and
cities), had their own local laws governing land and some of these had
permitted commercial land ownership for some time. The Land Code
requires all regional land legislation to be brought into line with the
provisions of the Land Code itself.
As a general rule, the Land Code only applies to transactions
occurring after its enactment. Pre-existing ownership rights, which
are now inconsistent with the provisions of the Land Code, however,
have to be re-registered. In particular, a permanent right to use of
land should be re-registered as a lease or the right of ownership to the
land should be purchased prior to 1 January 2006. Only state and
municipal institutions, federal state-owned enterprises, governmental and local government bodies do not need to re-register their
permanent rights to use of the land plots. Individuals or legal entities
whose permanent right to use of the land plot has not been reregistered are not entitled to dispose of their land plots. Similarly,
where a building (or other item of immovable property such as a rig or
a bridge) has been acquired, the land underneath that structure, or
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the land which is necessary for its use, and which had previously been
granted as a permanent right of use should be re-registered as a lease
or the land acquired outright.
Unless and until land plots to which an earlier registered right of
permanent use is attached are re-registered, further dealings with that
land will not be permitted. In particular, it should be noted that it is no
longer permissible for a permanent right to use land to be contributed
to the charter capital of a company.
It is a general principle of the Land Code that foreign individuals
and legal entities are to have the same rights to land as local residents. Despite this, there are certain restrictions applicable to
foreigners. A foreign national, for example, may not own land located
in border and other special territories. A list of such land plots is still
to be approved by the President of the Russian Federation. The Land
Code also provides that further restrictions may be imposed on
foreigners leasing land but no additional restrictions have yet been
enacted.
In some instances described in the Land Code, and in the regional
land legislation, residents may be entitled to receive land free from the
State. Foreigners, on the other hand, may only acquire land for a
valuable consideration.
Lease of land
There is no limit to the term of a lease of land. A lessee has a priority
over any subsequent lease of the same plot and, on the sale of the land,
a priority right to its purchase. Leasehold rights may themselves be
sub-let, assigned, sold or contributed to the charter capital of another
entity. Unless otherwise provided for by the lease agreement, the aforementioned transactions can be entered into without the consent of (but
after notification to) the lessor.
Land may be leased by companies and individuals whether Russian
or foreign. In practice, leases are generally granted for a maximum
term of 49 years and a lessee usually has a preferential right to renew
the lease on expiry. The exact terms and conditions of a lease
agreement will depend on negotiations between the lessor and lessee,
but every lease should conform with the detailed requirements set out
in the Civil Code and the Land Code.
Any change to the terms of the lease agreement requires the
consent of both parties. Early termination by the lessor of a lease
agreement with a term of five or more years will require a court order.
An application for such an order can only be made where there has
been a material breach of the terms of the lease agreement by the
lessee.
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Agricultural land
Agricultural land has been excluded from the provisions of the Land Code
and a specific law on agricultural land was adopted on 24 July 2002.
The Law on Agricultural Land provides that foreign legal entities,
foreign individuals and Russian legal entities in which foreigners
control more than 50 per cent of the charter capital may not own agricultural land. They are instead only permitted to lease agricultural
land and for up to a maximum period of 49 years.
The further amendments made to the Law on Agricultural Land
adopted in June 2003 provide for preferential rights of the State and, if
provided by the law, municipal authorities to acquire agricultural land
in all cases except by acquisition at a public auction.
Buildings
One of the principles of the Land Code is to keep buildings and the land
on which they are situated in the same ownership. The Land Code only
allows buildings to be disposed of separately from the land on which
they are situated if: (a) it is not possible to separate out the land (for
example, a condominium); or (b) the sale and purchase of the land is
restricted (army land, border areas etc).
Where land is to be sold by a private entity, the owner of any
building situated on that land will have priority in acquiring the land.
If the owner of the building chooses not to buy the land then the landowner can sell it to a third party. Where the land is to be sold by the
State, however, the owner of any building on that land will have an
exclusive right to purchase it: if the building-owner chooses not to so
purchase, the State cannot sell the land to anyone else. Thus, buildings
may be owned by individuals and companies including foreign
investors, but the land beneath those structures, if not owned with the
building, will remain state (or private) property.
Mineral resources
Ownership of a plot of land will not include ownership rights of the
resources situated beneath that land. Such resources remain state
property and may be exploited only in accordance with the provisions
of the relevant sub-soil legislation.
Building leases
Buildings and parts of a building may also be leased. The terms and conditions of the lease agreement are regulated by the provisions of the Civil
Code. These include, for example, general duties imposed on the lessee to
287
pay the rent agreed, to maintain the property in good repair, to pay compensation on alterations for any improvements made, and gives a preferential
right to renew the lease. Leases for more than one year must be in writing
and must be registered with the relevant authority, which in Moscow is the
Committee for the State Registration of Real Property Rights and
Transactions Therewith within the territory of the City of Moscow.
Rent payable on real estate leases is subject to VAT at a rate of 18
per cent. An exemption from VAT is provided on lease payments made
by the representative offices of companies incorporated in most
Western European countries and the United States.
Mortgage
There are no restrictions in the Land Code on the grant of security over
land. Article 3 of the Land Code expressly states that this issue is to be
regulated by the general civil legislation unless there are specific
provisions to the contrary (thus, for example, a pledge cannot be taken
over land that cannot itself be owned by foreigners). The Civil Code
provides that a land plot can be mortgaged, while Article 22 of the Land
Code authorizes lease rights to be pledged.
It should be noted that the Land Code does not prescribe any
particular requirements as to the form or content of agreements for the
mortgage of land, which are regulated by the Civil Code and the Law
On Mortgages of 22 July 1998. Mortgages must be certified by a
Russian notary and registered with the appropriate registration
authority. Buildings and other real estate may be mortgaged but only
together with whatever rights the building owner has to the land
beneath the building. Residential houses and apartments can also be
subject to mortgage as can leasehold interests in real property.
In the event of default, a mortgagee may enforce its right to
possession of real estate only through court proceedings unless the
parties agree otherwise. In either case, the property that is subject to
the mortgage will be sold at a public auction organized either by the
court or by specially registered auction companies.
The Law on Mortgage Securities came into force in Autumn 2003.
The Law sets out the requirements and conditions for the issue, certification and allocation of mortgage securities and their execution. The
Law on Mortgage Securities provides for the further development of
the real estate market in Russia.
Dispute resolution
The Land Code stipulates that disputes involving land are to be settled
in court proceedings although, prior to such proceedings commencing,
any dispute can be referred to arbitration.
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In accordance with the Civil Procedure Code and the Arbitration

Procedure Code, disputes concerning immovable property (including
land) are within the exclusive competence of the courts of the Russian
Federation. In connection with this, Article 64 of the Land Code, which
allows a dispute to be referred to arbitration, would appear to be in
conflict with the legislation on jurisdiction. Pending an official explanation of this provision, we would recommend incorporating into
contracts for transactions involving immovable property a clause
providing for the submission of disputes to the non-exclusive jurisdiction of a pre-determined arbitration body.
Registration
The ownership and other property rights in immovable property,
encumbrances over these rights, their acquisition, transfer and termination should be registered by the relevant local registration authority
under the Ministry of Justice in accordance with the Law on State
Registration of Rights to Immovable Property and Transactions
Therewith. Such registration is effective as confirmation of title. Rights
that are created or transactions that are completed without registration (other than lease agreements for less than one year) are not
valid unless and until they are properly registered. The appropriate
authority in Moscow is the Committee for the State Registration of
Real Property Rights and Transactions Therewith within the territory
of the City of Moscow. The information contained in the State Register
is available for inspection after payment of a fee.
Payments for real estate

Payments for real estate in Russia made to Russian individuals or
Russian entities, whether lease payments or payments of a purchase
price, are subject to Russian currency control and should be made in
roubles.
It is not uncommon for the price of many commodities, including
land, to be quoted in a foreign currency, usually US dollars. Payment is
then made in roubles by reference to the Central Bank rate of exchange
applicable for the day of payment.
Use
The specific use of land and buildings is usually defined by the State
Register of Real Property Rights and Real Property Transactions. The
most significant distinction is between residential and non-residential
use.
5.2
Land Relations in the

Russian Federation
Andrey Goltsblat, Managing Partner,
The coming into force of the Land Code in 2001 and the adoption of the
Law On Farm Land Turnover caused an increased investor interest in
land. The Land Code made more favourable the terms and conditions
for the turnover of land plots and their acquisition, including through
privatization.
Current Russian legislation sets forth the principle of plurality of
ownership rights to land: the law treats as legally equal the right of
land ownership of the Russian Federation (federal property), the
constituent entities of the Russian Federation, municipalities, legal
entities and individuals. All land owners enjoy equal protection. Unless
otherwise provided by law, the right of ownership in a plot of land
extends to the surface (soil) layer and closed reservoirs within the
boundaries of this land plot and to the forest and plants that grow on it.
Rights to land plots are primarily acquired in Russia through:
a transaction with a land plot itself (purchase and sale, lease,
exchange, gift, contribution to authorized capital, etc);
acquisition of ownership interests in land (interests in common
ownership of farm land) with a possibility of subsequent land apportionment;
acquisition of shares (ownership interests) in a legal entity owning a
land plot.
Owners of a land plot have the right to sell it, give it as a gift, erect
buildings and structure thereon, pledge, lease out or otherwise dispose
of it with regard to particularities, as set out in land laws.
The types of objects of land parcels that are barred from circulation
should be expressly specified by law. For example, withdrawn from
circulation are the lands of wildlife sanctuaries and national parks,
290
lands under defence, security and atomic energy facilities, lands used
for military and civil burials, etc. Restrictions have been imposed on
the circulation of plots of forested land, farm land contaminated by
hazardous waste and radioactive substances, other lands that have
been subjected to degradation, etc.
Purchased, sold, leased out or otherwise disposed of can be only those
land plots that are recorded in the State Land Cadaster and the rights to
which are registered, as required by Russian laws. Marketable land plots
are identified by means of cadastre registration the description and
individualization of a land plot that results in assigning attributes to the
land plot that unambiguously distinguish it from other real estate
assets. The coming into force of the amendments to the Law On Farm
Land Turnover made it possible in a number of constituent entities of
the Russian Federation to privatize farm land after 1 January 2004.
One of the specific features of the new Russian legislation is a
special legal framework for land possession applicable to foreign individuals, foreign legal entities and stateless persons. For these categories of landholders certain restrictions have been imposed by the
current laws:
their rights to land plots require payment in all cases and in no
event may such rights be transferred gratuitously (unlike Russian
condominiums and individuals who are allowed, in a number of
specified cases, to acquire such rights gratuitously);
foreign legal entities, foreign individuals and stateless persons are
not allowed to own land in frontier areas (the list of which should be
set up by Presidential decree) and in other specially designated
territories, as provided by federal law.
In addition, there are certain statutory restrictions in relation to the
acquisition of title to plots of farm land:
foreign individuals, stateless persons and foreign legal entities may
only possess and use plots of farm land based on a lease agreement;
Russian legal entities with more than a 50 per cent ownership
interest held by foreign individuals, stateless persons and foreign
legal entities may only hold plots of farm land on lease;
the constituent entities of the Russian Federation should set the
lower limits for plots of farm land and overall upper limits for farm
lands that may be concurrently owned by an individual, his/her relatives and legal entities where this individual and his/her relatives
have more than 50 per cent of the votes; such limit of the total area of
farm land in the territory of one constituent entity of the Russian
Federation may not be less than 10 per cent of the total area of farm
land within the boundaries of one administrative and territorial unit.
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However, the vagueness and ambiguity of certain statutory provisions

are raising apprehension among investors conducting land transactions. This apprehension is indeed well-grounded for there are no
clearly identified market benchmarks and no objective methods to
assess the market value of land; the land registration system is in its
infancy stage and there has been no delimitation of state-owned lands.
Quite often investors face difficulties in identifying the actual owner of
a particular land plot or interests in land.
For instance, in the event of shared land ownership, if an investor
(not one of the land co-owners but a third party) wishes to acquire a
land plot that is in shared ownership, under the Civil Code (unlike that
required under the Law On Farm Land Turnover) the investor is
required to obtain all co-owners consent. This may prove difficult in
reality, since more often than not the number of land owners runs into
hundreds. We have developed and are successfully using our own
methods to cope with potential difficulties.
Investors frequently have apprehension related to the land plot
forming procedure: it is difficult not only to find a suitable land plot but
also to obtain this particular land plot for a project (be it construction of
a plant, crop growing, etc).
Given that the Russian Constitution refers privatization laws and
land legislation to the joint competence of the Russian Federation and
its constituent entities, the specifics of legislation in each particular
constituent entity of the Russian Federation need to be taken into
account when conducting transactions. In addition, the regional and
local authorities use different approaches to offering incentives for
buying out or leasing land in their regions. When choosing a land plot it
is important to take into consideration the specific features of regional
legislation, which affect the terms on which the land plot may be
granted, and deal with the local authorities individually.
The Russian land legislation distinguishes between seven basic
land categories depending on the intended use of land, including farm
land, lands under settlements, industrial land, etc.
The lands pertaining to a certain category must be used only as
intended. Legal framework for lands depends on the category they fall
under and permitted use in accordance with territorial zoning. Any
type of permitted use is chosen by the land user independently and
does not require any additional permits or approvals.
For objective reasons and for reasons of expediency, economics,
social issues and the like, it is possible to convert land from one land
use category to another. Such conversion requires that special rules
and conditions be observed. The decision on land conversion falls
within the competence of different authorities, depending on how the
land plot is categorized and who its owner is.
The land legislation highlights as a priority the need to preserve
especially valuable lands and lands of especially guarded territories.
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The law provides that withdrawal of valuable farm lands, forested

lands, lands under first-class forests, lands occupied by especially
guarded natural territories and facilities, lands occupied by cultural
heritage assets, other especially valuable lands and lands of especially
guarded territories for other purposes is limited or prohibited, as
provided by federal laws. For the construction of industrial facilities on
farm land and for other non-agricultural needs, lands unfit for farming
or farm lands of inferior quality in terms of cadastre value are granted.
Withdrawal for non-agricultural purposes, including by means of a
buy-out, of farm land with a cadastre value exceeding the average
figure across the district is allowed as an exception, if required for the
performance of the international obligations of the Russian
Federation, for defence or security reasons, development of mineral
deposits (except for common minerals), maintenance of cultural
heritage assets of the Russian Federation, construction and maintenance of cultural, social and educational facilities, motorways, trunk
pipelines, power supply lines, communication lines and other similar
facilities.
Particularly valuable productive farm lands, including farm lands of
experimental production units of research institutions and training
and experimental units of higher educational establishments, and
farm lands with a cadastre value exceeding the average figure for the
district may be included in the list of lands that are not allowed to be
used for other purposes, as provided by the laws of the constituent
entities of the Russian Federation.
The conversion of forested land to non-forested land for purposes
other than forestry operation or forest use, and/or withdrawal of
forested land in first-class forests fall within the competence of the
Russian Government, while in second and third-class forests such
conversion and/or withdrawal are the responsibility of the authorities
of a particular constituent entity of the Russian Federation.
In any event, when construction or mining operations are performed
damaging the soil layer, the fertile layer of soil is removed and used to
improve low-productive lands. Provided the removed fertile layer of
soil is put on low-productive or non-productive farm lands, the rate at
which farm industry losses are required to be reimbursed may be
halved.
To avoid unpleasant surprises in land transactions attention should
be paid to certain inconsistencies and discrepancies in regulatory acts
such as:
the inconsistency between the provisions of civil laws and land laws
in relation to the legal destiny of land plots and real estate assets
located thereon, when the owner of the land and the assets separates out only the land or only an asset;
293
the discrepancy between the provisions of land legislation and

privatization laws governing price calculations for land plots that
are subject to privatization;
the discrepancy between the provisions of land legislation and
privatization laws as to the gratuitous or not gratuitous basis of
land privatization under certain circumstances;
insufficient legal regulation for situations where there is a combination of rights in personam and rights in rem in relation to one and
the same land plot. What we mean by this is a fairly common situation where a party holding a land plot based on the right of
perpetual (indefinite) use, leases out this land plot with the owners
consent to a third party for real estate development, etc.
When conducting transactions with land plots, in each particular case
it is necessary to consider all surrounding circumstances and the
specific features of the legal status of the objects of and parties to each
single transaction.
Copyright 2004 Pepeliaev, Goltsblat & Partners LLC. All Rights Reserved.
5.3
Intellectual Property
and E-commerce
CMS Cameron McKenna
Introduction
The main types of intellectual property that are recognized and
protected by Russian law include:
trade marks;
copyright (including computer programs) and neighbouring rights;
patents.
Trade marks
Principal legislation: Laws and normative acts
Trade marks are subject to the following principal legal acts:
the Civil Code;
the Law On Trade marks; and
regulations of the Patent Office.
Concept of a trade mark

According to the Law On Trade Marks, a trade mark is a designation
that distinguishes the goods and services of one economic entity from
those of another. A trade mark may take the form of a design, a symbol
or a three-dimensional object, or a combination of these, and may be
any colour or combination of colours.
The Law On Trade Marks provides a list of designations that may
not be registered as trade marks. These include state flags and
emblems, the names of state and international organizations, official
Intellectual Property and E-commerce
295
marks such as hallmarks or stamps of approval, generally used designations of particular kinds of goods, and generally accepted symbols
and terms.
The owner of a trade mark has an exclusive right to use and dispose
of the trade mark and to prohibit its use by others. Any manufacture,
use, import, offer for sale, sale or other putting into commercial
turnover or storage with a purpose to put into commercial turnover of
a trade mark, goods marked with the trade mark or a designation
confusingly similar to the trade mark in respect of similar goods
without the owners consent is a violation of the exclusive right of the
trade mark owner. Goods bearing trade marks that violate the
exclusive right of a trade mark owner, will be considered counterfeit
and may be seized and destroyed pursuant to a court decision.
Trade mark criteria

To be registered as a trade mark, a designation should not lead to
confusion on the part of the public or be contrary to the public interest
or principles of humanism or morality.
Designations that are identical to or confusingly similar to registered trade marks, well-known trade marks, names of characters or
quotations from literature, science or art, names, pseudonyms or
portraits of famous people may not be registered as trade marks.
Protection of trade marks

Registration of trade marks
According to the Law On Trade marks, protection is granted on the
basis of registration. A trade mark may be registered only by a legal
entity or an individual entrepreneur registered as such with the tax
authorities.
Trade marks are registered with the Patent Office, which issues a
trade mark certificate. The legislation sets out the procedure, fees and
requisite documents for registration. Applications by foreign
entities/foreign individuals must be submitted only through trade
mark attorneys registered with the Patent Office.
Priority is given from the date an application for registration is
made, or an earlier date if the application was first made under the
Paris Convention in another member state or the goods were first
exhibited in a member state. The priority date may also be established
according to the date of international registration under an international treaty of the Russian Federation.
Registration is a time-consuming process, which may take from 18
to 24 months to complete. The Patent Office will make an entry in the
State Register of Trade Marks and issue a certificate of registration.
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Information concerning the trade mark is also published in the official

bulletin of the Patent Office.
Time period and conditions of protection
A trade mark certificate is valid for ten years from the date of application.
This term may be extended for another ten years upon application by the
trade mark owner in the last year of the ten-year period. Extension is
subject to a fee and is reflected in the State Register and the certificate.
The registered trade mark must be used. The use of the trade mark
is its application on goods or packaging either by the owner or a
licensee. Protection may be revoked if the trade mark was registered in
the name of a person who is not an individual entrepreneur or in
breach of trade mark criteria or was not used in the Russian
Federation during the previous three years.
Troubleshooting
If the rights of a trade mark owner are infringed, he may apply to the
Chamber for Patent Disputes of the Patent Office or to an arbitrazhniy
(commercial) court.
The registration of a trade mark may be challenged by application to
the Chamber for Patent Disputes of the Patent Office. If the trade mark
was registered, for example, in the name of an individual who is not an
entrepreneur or the trade mark is not used, the Chamber for Patent
Disputes may consider the registration void.
Disputes regarding violation of rights of a trade mark owner or
relating to licensing or assignment agreements fall within the jurisdiction of state arbitrazhniy (commercial) courts.
Remedies available to the owner of a trade mark include suing for
damages and/or obtaining injunctions against the infringer requiring
the infringer to delete the trade mark from goods or to destroy a designation, or goods bearing a designation that is confusingly similar to the
trade mark. Alternatively, instead of claiming for damages the owner of
a trade mark may claim for a fixed amount of compensation ranging
from $3,400 to $170,000 (being correspondingly 1,000 times and 50,000
times the statutory minimum monthly wage, which on 1 January 2004
was 100 roubles or $3.4).
The owner of the trade mark may also apply to the Ministry of AntiMonopoly Policy with a request to delete a particular designation that
is so confusingly similar to a registered trade mark that competition
would be affected and consumers confused.
Trade mark owners may also apply to the police with a request to
open a criminal case against an infringer. According to the Criminal
Code of the Russian Federation, an individual who intentionally
repeatedly and illegally uses a registered trade mark may be fined up
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to $6,800, fined an amount equal to his income for a period of up to 18

months, or subjected to mandatory works for a period from 180 to 240
hours, or be sentenced to up to two years of hard labour.
Foreign companies may also request to the customs authorities to
prevent the import of goods having a designation infringing the rights
of a trade mark owner.
Assignment, licences, need to register

Trade marks may be assigned and the right to use the trade mark may
be licensed to a third party. Both an assignment agreement and a
licence agreement must be made in writing and must be registered with
the Patent Office. Failure to register renders these agreements void.
Copyright and neighbouring rights

Principal legislation: laws and normative acts
The principal laws governing copyright and neighbouring rights are:
the Civil Code;
the Fundamentals of the Civil Legislation (Part IV of the Civil Code
of the RF governing the IP rights is expected to be submitted to the
Russian Parliament for consideration during 2004, replacing the
Fundamentals of the Civil Legislation);
the Law On Copyright and Neighbouring Rights;
the Law On the Legal Protection of Computer Programs and
Databases.
Concept of copyright
Copyright protection is granted to a work that is the product of creative
activity and that is expressed in any material form. Such works include
literary, dramatic, musical, choreographic and audio-visual works,
sculptures, designs, photography and computer programs. Copyright
protection does not apply to ideas, methods, concepts, principles, discoveries, facts, official documents, state symbols and information on events.
Rights of the author that may and may not be assigned

The author is entitled to:
be recognized as the author of the work;
protect his name as the author;
preserve the integrity of the work;
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publish and use the work;

access the work.
These rights are not transferable and rest with the author even if other
exclusive rights, such as, for example, the right to reproduce,
distribute, import, demonstrate, communicate, translate and redraft
the work, are assigned to other people.
The author is entitled to receive remuneration from the use of his
work by other people. There are very limited circumstances where the
protected work may be used without permission of the copyright owner
and without remuneration.
Concept of neighbouring rights

Neighbouring rights belong to performers. According to the Law On
Copyright, a performer is an actor, singer, musician, dancer or other
person who performs the work in any way, including a director of a film
and a conductor.
No registration, by act of creation

Copyright protection is granted by virtue of creation. No registration or
other special procedure is required.
Time period for protection

As a general rule, copyright is valid during the lifetime of the author
and for 50 years after his death. Some rights of the author, such as a
right to be recognized as the author, are protected with no time limit.
Troubleshooting
According to reservations made by Russia on joining international
conventions, protection under international treaties is granted for
works first published after Russia joined those conventions.
With regard to copyright, the earliest date for granting protection is
27 May 1973, when the Universal Convention on Copyright became
effective for the Soviet Union. Any work first published before this date
in any other member state of the convention was not protected in the
Soviet Union and is not protected in Russia. In addition, works first
published later but in a country that is not a member of the Universal
Convention are not protected either.
In order to protect their rights, copyright owners may apply to the
courts, to arbitration and to the police. Remedies available to the owners
include the recognition of their rights and compensation for damage.
Counterfeit goods and equipment for the manufacture of counterfeit
goods may be seized and destroyed in accordance with a court decision.
299
Upon filing an application to the court, copyright owners are also

entitled to obtain an injunction to prevent counterfeiting activities of
an infringer and to seize counterfeit goods and equipment for their
manufacture.
An infringement of copyright also constitutes a criminal offence,
which may be investigated by the police. Under the Russian Criminal
Code (Criminal Code) an individual who intentionally infringes an
authors intellectual property rights and purchases, stores and/or
transports counterfeit works may be fined up to $6,800, fined an
amount equal to his income for a period of 18 months, be subjected to
mandatory works for a period from 180 to 240 hours, or be imprisoned
for a period of up to two years. Plagiarism is also considered a criminal
offence under the Criminal Code, which stipulates that an individual
who intentionally uses someone elses works may be fined up to $6,800,
fined an amount equal to his income for a period of 18 months, be
subjected to mandatory works for a period from 180 to 240 hours, or be
sentenced to hard labour for a period from three to six months.
Infringers of an authors intellectual property rights, the intentional
and illegal purchase, storage and transportation of counterfeit
products with a value exceeding $8,500 or infringement by a group of
people or by an official are punishable by imprisonment of up to five
years and a fine of up to $17,000 or an amount equal to the infringers
income for a period of up to three years.
Patents
Principal legislation: laws and normative acts
The principal laws regulating patents are:
the Civil Code;
the Patent Law;
the Regulations of the Patent Office.
Concept of a patent
A patent may be granted for:
an invention;
a utility model;
an industrial design.
A patent holder has exclusive rights to use an invention, utility model
or industrial design, and to prohibit its use by others.
300
A patent holder may assign their rights or license the patent by way
of a licence agreement to third parties. Such assignment and licence
agreements must be registered with the Patent Office and failure to
register will render a licence agreement and assignment agreement
invalid.
Patent criteria
In order to qualify for protection by patent, an invention must be new,
have an element of invention and be capable of industrial application.
A utility model to qualify for the same must be new and be ready for an
industrial use. For an industrial design to be registered, it must be new
and original.
Registration
Patents must be registered with the Patent Office. The registration and
issuing of patents involves application, expert examination and publication of information about the patent. The Patent Office sets out the
rules for application.
The priority date is the date of application for registration or an earlier
date if the application was first made under the Paris Convention.
Time period of protection

Protection is granted for a period of 20 years for an invention, five
years for a utility model and ten years for an industrial design. The
protection period can be extended by the Patent Office upon application of a patent holder for up to five years for an invention industrial
design and up to three years for a utility model.
Troubleshooting
If the rights of the patent holder are infringed he may apply to the
Chamber for Patent Disputes of the Patent Office, to courts, or to arbitration. The registration of a patent may be challenged by application
to the Chamber for Patent Disputes of the Patent Office.
Disputes regarding violation of exclusive rights of the patent holder
or relating to licensing and assignment agreements, as well as the
illegal use of the patent, fall within the jurisdiction of courts of common
jurisdiction if one of the parties is an individual, or the state arbitrazhniy courts if all parties are legal entities, or individual
entrepreneurs.
The patent holder is entitled to injunctive relief, compensation for
damages caused by illegal use of the patent. Infringement of a patent
also constitutes a criminal offence within the jurisdiction of the police.
Under the Russian Criminal Code an individual who intentionally and
301
illegally uses or discloses (prior to official publication) a patented

invention, a utility model or an industrial design may either have to
pay a fine of up to $6,800, a fine of an amount equal to his income for a
period of up to 18 months, or be subjected to mandatory works for a
period from 180 to 240 hours, or be imprisoned for a period of up to two
years.
Infringement by a group of people is punishable either by a fine of
between $3,400 and $10,200, a fine of an amount equal to the
infringers income for a period of between one and two years, or be
arrested for a period from four to six months, or by imprisonment for up
to five years.
International treaties: Russia as legal successor

to the Soviet Union
Russia is a member of the World Organization of Intellectual Property.
As legal successor to the Soviet Union, Russia is also party to a number
of international treaties including the Paris Convention for the
Protection of Intellectual Property (1883), the Geneva Convention for
the Protection of Phonograms (1971), the Madrid Agreement for the
International Registration of Marks (1891), the Universal Copyright
Convention (1952), and the Treaty on Patent Co-operation (1970). On
3 March 1995 Russia became a full member of the Berne Convention.
Russia is also party to a number of bilateral agreements on the
protection of intellectual property for example, with Austria,
Bulgaria, Sweden and Slovakia. Bilateral agreements extend
protection to works published both before and after the signature date.
Finally, in 1993 Russia and other CIS countries signed the Agreement
on Measures for Protection of Intellectual Property and the Agreement
on Co-operation in the Sphere of Copyright Protection.
E-commerce
Lack of regulation
The legal regulation and enforcement of the Internet in Russia is an
area that is only now starting to be developed and thus court practice
remains undeveloped and somewhat contradictory. For example, registration of domain names is not regulated by any legal act of
government or parliament, nor has the legal status of domain names
been clearly defined by the courts.
The registration of domain names is carried out by the Russian
Institute for Public Networks, a non-commercial partnership established by the Ministry of Science, the Ministry of University Education
302
and the Scientific Research Institute named after academic,

Kurchatov. It is responsible for the development of the Russian zone on
the Internet. This authority was delegated to the Russian Institute for
Public Networks by the International Network Information Centre
(InterNIC).
Squatting, piracy, domain names and IP rights

Prior to 1 June 2000 the registration of domain names was a low cost
procedure. Any person willing to register a domain name simply applied
to the Russian Institute for Public Networks and had to pay a registration fee within three months of registration. Maintenance of the
registration was also subject to a nominal annual fee. Failure to pay the
fee did not prevent the person from applying for registration of the same
domain name again. This led to a rush of cyber-squatting activity.
Of growing concern is copyright protection on the Internet. Russian
law does not provide clear guidance as to what remedies may be
available to a copyright owner when his rights are infringed by a site
operator. The owner of the copyright might find limited comfort in the
Copyright Law, which prohibits unauthorized communication of copyright-protected works by means of cable or wire transfer and other
analogous means, or unauthorized distribution by means of copying
and distribution of copies of the work by any means.
To register a domain name, an applicant must pay a registration fee
of $20 (VAT excluded) and an annual registration maintenance fee of
$15.
Domain names are divided into the categories of geographical and
generic (for example, ac.ru, org.ru, net.ru), public (those that are not
geographical or generic) and corporate (all other domain names).
The Rules for Resolving Disputes Over Domain Names were developed
on the basis of the Uniform Domain Name Dispute Resolution Policy
recommended by WIPO and accepted by ICANN. The Rules provide
protection for trade mark owners against owners of domain names that
infringe the intellectual property rights of trade mark owners.
According to the Rules, the registration of a domain name should be
cancelled if it is proved that the domain name (i) is identical or confusingly similar to a trade mark, and (ii) was registered or used in bad
faith.
A domain name is deemed to be registered or used in bad faith if it
was registered or used:
mainly with the purpose of a later assignment to the trade mark
owner for a remuneration considerably exceeding the cost of
registration;
to prevent the trade mark owner from registering the domain name;
303
to obstruct the activities of the trade mark owner as a competitor of

the domain name owner; or
in commercial interest and with an intention to attract third parties
to the Internet resources of the domain name owner thus creating a
possibility that the trade mark will be considered by third parties as
having a connection with the domain name holder.
Although the Rules that apply to disputes considered by an arbitration
forum at the Russian Institute for Public Networks do not provide for
compensation for damages, they do leave open the possibility to apply
to state courts for an award of damages.
Contracts via the Internet: Legislation on electronic

signatures
The regulatory framework for e-commerce is only now emerging in
Russia and only the Law on Electronic Signatures has been adopted so
far. A number of other drafts exist and some of them are presently at
committee stage in the Russian parliament.
There are drafts of the Law On Electronic Commerce, the Law On
Electronic Documents and the Law on Electronic Financial Services.
There is even a proposed draft of a federal programme on e-commerce.
The first step in developing e-commerce was the adoption of the Law
on Electronic Signatures, which came into force on 12 January 2002.
The Law On Electronic Signatures defines an electronic digital
signature as a cryptographic symbol that depends on public key cryptography technology to decode it. The cryptography is the exclusive
public domain of the Federal Agency of Governmental Communication
and Information (FAPSI), which allows additional state control over
the electronic transactions.
A draft of the Law on Electronic Commerce was passed by the
Russian State Duma (the lower chamber of the Russian Parliament) in
its first hearing on 6 June 2001. The draft law is designed to establish
procedures for electronic transactions. It has yet to be passed in a
further two hearings, adopted by the Federation Council and signed
into law by the President.
At present there is no sub-regulation applicable to electronic
contracts that would recognize electronic transactions.
Taxation of purchases made through the Internet

Purchases of goods transferable through the Internet are not taxed, as
a means for tracking such purchases and assessing taxes does not
presently exist. If goods are bought through the Internet and then
delivered to customer in a material form, they would be subject to all
existing Russian taxes and customs duties.
5.4
Arbitration and Dispute

Resolution
CMS Cameron McKenna
The courts
The financial crisis of 1998 led to a significant increase in the number
and complexity of disputes being referred to the commercial courts in
Russia, particularly the Moscow Arbitrazhniy (commercial) Court.
This was something of a baptism of fire for many of the judges who
found themselves being asked to consider complex issues of fact and
law, often under close scrutiny both from at home and abroad.
Although many Russian lawyers will claim that Russia is a civil law
system and, therefore, individual court decisions do not create precedents that are binding on other judges and courts, in practice the
significance of case law has increased greatly in the last few years. As
in other civil law jurisdictions, Russian judges and lawyers are realizing the value of case reports that can give guidance on how previous
cases were decided. A judge may not be required to follow precedents
but he may be persuaded by them.
This chapter describes the court structure and the basic elements of
litigation in Russia. Calls for the reform of the Russian legal system
can often be heard but perhaps the most pressing need is to improve
the quality and number of judges and the court facilities in which they
are required to work. An average judge in the Moscow Arbitrazhniy
Court is reportedly required to handle around 450 cases each year an
intolerable workload.
Structure
The jurisdiction of the Russian courts is principally divided between
the courts of common jurisdiction and the state arbitrazhniy courts
(see Figures 5.4.1 and 5.4.2), which between them deal with civil,
criminal and commercial matters. There is also a separate constitutional court. It should be noted here that the arbitrazhniy courts are
305
often referred to as arbitration courts. This can be confusing since the

arbitrazhniy courts are state-run like their counterparts in the West.
They should not be confused with commercial arbitration bodies that
administer private arbitrations by agreement between the parties.
These arbitration bodies operate independently from the State.
The Russian court system also includes federal military courts and
so-called specialized courts. In addition, a system of single judges
(mirovye sudyi) has recently been created to hear minor disputes.
The structure, jurisdiction and procedure of the courts of common
jurisdiction are set out in the Federal Law On the Court System of the
Russian Federation. The courts of common jurisdiction are organized
on the basis of first instance district or municipal trial courts; second
instance regional appellate courts with geographically discrete jurisdictions; and a single national Supreme Court (based in Moscow),
which hears appeals from the regional appellate courts.
Under the Federal Law On Arbitrazhniy Courts in the Russian
Federation a system of arbitrazhniy courts was set up to deal with
commercial disputes. These separate state arbitrazhniy courts have
their own structure, jurisdiction and procedure as defined by the
Arbitrazhniy Procedural Code.
Arbitrazhniy Courts of the Constituent Subjects of the Russian
Federation are courts of both first instance and of appeals. Next there
are the Federal District Arbitrazhniy Courts, of which there are roughly
10 throughout Russia. These district courts hear cassation applications
(which are described below) from the regional courts. The Russian
Supreme Arbitrazhniy Court occupies the highest level and exercises a
supervisory role over the regional and district arbitrazhniy courts.
Supreme Court
Petition for appeal
Regional Appellate
Court
Automatic right of
appeal on fact and law
District or Municipal
Court
Figure 5.4.1 Courts of common jurisdiction
306
Supreme Arbitrazhniy
Court
Petition for appeal
Federal District Court

(cassation)
Automatic right of appeal
Appeals instance
three judges
Regional Arbitrazhniy
Court
Automatic right of
appeal on fact and law
First instance
one judge
Figure 5.4.2 Arbitrazhniy or commercial courts
Although jurisdictionally separate, the Supreme Court and the

Supreme Arbitrazhniy Court occasionally publish joint resolutions
summarizing their practice in relation to particular issues and giving
an authoritative interpretation of current law.
Courts of common jurisdiction: First instance

jurisdiction
In effect, any matter not assigned to be dealt with elsewhere is dealt
with by the courts of common jurisdiction.
Cases are normally commenced in the first instance district or
municipal courts. In very limited circumstances, for example, in cases
involving state secrets, a second instance regional appellate court may
act as a tribunal of first instance. The Supreme Court acts as the first
instance court for disputes arising in connection with the presidential
and parliamentary elections and some other administrative matters.
A defendant should usually be sued in the first instance court for the
area in which he resides, or, if the defendant is a firm, in the first
instance court for the area in which it has its registered office. If the
307
defendants whereabouts are unknown or if the defendant is resident

abroad, then the claimant may be able to issue proceedings in the court
of the region in which the defendants property is located.
The quorum of a first instance district or municipal court is usually
one professional judge, but in some circumstances the quorum will be
three such judges.
Courts of common jurisdiction: Appellate jurisdiction

The final judgement of a first instance court becomes enforceable after
ten days. During this period each party has a right of appeal on fact
and/or law to a regional appellate court. The appeal must be filed with
the court whose judgement is being appealed.
No new evidence may be adduced on appeal unless it was not
possible to present that evidence to the lower court. Respondents may
reply to the points raised in the appeal by submitting a written
response.
The quorum of an appellate court is three professional judges.
Decisions taken by a regional appellate court can be further appealed
to the supervisory appeal instance, the Presidium of the regional
appellate courts, and then to the Supreme Court. The Supreme Court
acts as the final court of appeal. It has the authority to reverse decisions
of all first instance courts and rulings by appellate courts.
State arbitrazhniy courts: First instance jurisdiction

The jurisdiction of the state arbitrazhniy courts is confined to cases of
a commercial or business nature. Any other type of dispute requiring
a hearing in a public forum must be tried by the court of common
jurisdiction.
Arbitration procedure rules set out that organizations may be represented in arbitrazhniy courts only by their respective heads within the
scope of their authority, by employees of the said organizations, or by
advocates. Thus, lawyers without the status of an advocate and those
not employed by an organizsation are not entitled to represent the
interests of their clients in arbitrazhniy courts.
As a general rule, an action should be started in the regional court
for the area in which the defendant resides. If the defendant is a firm,
then the action should be begun in the first instance court for the area
in which it has its registered office.
If there are two or more defendants and they are located in different
constituent subject territories of the Russian Federation, the claimant
can start the action in the relevant court for any of the relevant
constituent subject territories.
If the defendants whereabouts are unknown or if the defendant is
resident abroad, then the claimant may be able to issue proceedings in
308
the court for the region in which the defendants property is located. In
addition, if it is a contractual claim, legal action can be started in the
first instance court for the region in which the agreement is meant to
be performed. Whatever the location of the first instance court, it is
sometimes possible to transfer a case to an alternative arbitrazhniy
court of the same level of competence.
The quorum in a first instance state arbitrazhniy court is usually
one professional judge.
State arbitrazhniy courts: Appellate jurisdiction

Decisions of first instance arbitrazhniy courts become enforceable
after one month and during this time a party has the right of appeal on
fact and/or law to the appeals instance of the regional court that first
heard the case. The appellant cannot put forward new claims or adduce
new evidence, unless it was not possible to present that new evidence
at the first instance trial.
The appellant must serve a copy of the appeal documents filed with
the court on all the other parties at the first instance trial. They then
have a chance to enter a written response to the points raised in the
appeal. The response must be filed with the appellate court before the
date of the appeal hearing and served on any other parties.
Under the Arbitrazhniy Procedural Code of 2002 there is a distinct
appeal procedure called causation, under which a Federal District
Arbitrazhniy Court has the power to cancel a decision or ruling of a
regional arbitrazhniy court or find against appeal rulings by such courts.
The final court of appeal is the Russian Supreme Arbitrazhniy
Court, which has a supervisory appellate function empowering it to
revise the decision of any state arbitrazhniy court that is illegal or
lacking in legal substance.
The quorum of an appellate arbitrazhniy court is always an uneven
number of judges. A minimum of three is required, irrespective of the
level at which the appeal is heard.
Procedure
Generally speaking, the courts of common jurisdiction are open to all
members of the public over the age of 16. In principle, state arbitrazhniy
court proceedings are also open to the public. However, in practice,
special permission must be obtained to gain access to any hearing. In
addition, state arbitrazhniy courts will sit in closed hearing in order to
protect industrial secrets or commercially sensitive information.
Pleadings
Actions are begun in the court of common jurisdiction when a
claimant files a statement of claim with the appropriate first instance
309
court. The statement of claim will contain a mixture of alleged fact

and law, coupled with details of the evidence that the claimant
proposes to adduce at trial. However, the claimant can modify or add
to his claim at any stage up until the moment when the court retires to
consider its verdict. The service of the pleadings will be effected by the
court.
Under state arbitrazhniy court procedure, the claimant files a
written and signed statement of claim, just as he would do in a court
of common jurisdiction case. The statement of claim should also be
sent to the defendant, along with all supporting documents, prior to
filing the case with the court, and all post receipts should be attached
to the filings. While the defendant in a state arbitrazhniy court is
expressly entitled to service a written defence as well as a counterclaim, the claimant in the court of common procedure has no such
express right, although he will equally be permitted to serve a written
reply.
Evidence
Under both the Civil Procedural Code of 2002 and the Arbitrazhniy
Procedural Code of 2002, the judge handling the case is responsible for
preparing a case for trial. He will question the parties in an attempt to
clarify the issues in dispute between them. The judge may also instruct
the parties to deliver further documentary or other evidence to the
court and has the power to examine the parties experts before
commencement of the main hearing.
There is no mechanism for the pre-trial exchange of expert evidence.
In state arbitrazhniy court cases such evidence will be in written form.
In courts of common jurisdiction cases where experts are usually
court appointees in any event expert evidence will be required in oral
and written form.
Judgements
Usually the judgement will be given orally at the end of the
proceedings and a full verdict will be issued in writing within five days
after the proceedings have ended. If the court has consisted of more
than one judge, this will (if necessary) be a majority judgement.
Enforcement
The enforcement of all court judgements and orders by both courts of
common jurisdiction and state arbitrazhniy courts is dealt with by the
enforcement officer for the district in which the enforcement is to be
executed. Should it prove necessary, the officer can be assisted in his
duties by both the police and the militia.
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Litigation costs
In the courts of common jurisdiction, the costs consist of the court fee
plus the costs related to the trial of the case. In general, the claimant
has to pay the necessary state court fee when starting an action,
although there are certain exceptions.
The level of the state court fee will vary according to the value of the
claim. It is calculated using the fixed table set out in the Law Of the
Russian Federation Of the State Duty. The maximum fee for state arbitrazhniy courts is approximately $3,470. The maximum fee for the
courts of common jurisdiction is 1.5 per cent of the value of the claim.
Losing parties are usually ordered to pay the winners costs (including,
among other things, reasonable attorneys fees). If a claim or a defence
is only partially successful, then the cost award will reflect this.
Costs are dealt with in the same way in the state arbitrazhniy
courts.
Alternative dispute resolution mechanisms

Under the Arbitrazhniy Procedural Code of 2002, the judge has a duty
at the pre-trial preparation to encourage the parties to settle their
differences rather than engage in full-scale litigation. However, judges
in the courts of common jurisdiction do not have a similar statutory
duty and thus the public policy support for non-litigious civil dispute
resolution remains patchy.
In addition to these limited alternatives to dispute resolution
provided by the public court system, many arbitral bodies offer conciliation as well as arbitration services. However, formal alternative
dispute resolution procedures are rarely used in Russia at the present
time. Indeed, people are reluctant to use the new facility of private
arbitration even for their domestic disputes.
No concept of without prejudice negotiations or

settlement
Neither the Civil Procedure Code of 2002 nor the Arbitrazhniy
Procedural Code of 2002 restrict the ability of any party to plead in
evidence any negotiations or offers made by any other party before or
after proceedings are commenced. The practical effect of this is to
severely hamper any opportunity for the parties to resolve and settle
disputes without admitting liability. If an offer to settle is made then it
may be introduced into court proceedings as evidence of admission of
liability, and hence great care must be taken when dealing with
customer complaints and disputes of any kind.
5.5
Employment Law and

Work Permits for
Expatriates
CMS Cameron McKenna
As of 1 February 2002 a new Labour Code of the Russian Federation

came into force. The new Labour Code replaced the previous Labour
Code, which was adopted 30 years ago when the Soviet state was the
only employer and concepts such as entrepreneurship and private
property were largely unknown in Russia.
The new Labour Code deals with the following principal issues: the
rights and obligations of employees and employers; trade unions and
their regulation; the procedure for making, amending and terminating
employment contracts; salary payments; the State as employer; and
the procedure for dealing with employment disputes.
Employment contracts
Russian law distinguishes between an employment contract, which is
subject to the Labour Code, and a civil law contract between an organization and an individual for the provision of services. For the purposes of
this chapter, we will be dealing with the former unless otherwise stated.
Employment agreements should be made in writing although the
Labour Code provides that an employee who starts working without a
written agreement is nevertheless to be treated as an employee to
whom all the provisions of the Labour Code will apply.
Employment agreements may be concluded:
for an indefinite period of time; or
for a fixed period of time (but not exceeding five years).
The application of fixed term contracts is generally limited to work
requiring fixed term employment (ie to replace a sick employee, for
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fixed term projects, etc), but the new Labour Code specifically extended
the possibility of fixed term employment contracts for directors and
deputy directors of legal entities, chief accountants, retired persons
and employees working outside Russia.
A probation period of up to three months may be specified, although
this maximum limit can be extended to six months for certain executive staff including directors, managers and chief accountants. Three
days prior to the expiration of the probation period both the employer
and the employee have to notify each other in writing of the termination of the contract. Moreover, the employer should indicate reasons
for the termination.
The new Labour Code provides a list of mandatory provisions, which
should be included in the Employment Agreement and sets out a list of
documents that an employer may request from an employee at the
time of hiring.
Working hours and holidays

The statutory working week may not exceed 40 hours. Despite this, the
Labour Code does envisage extra hours being worked and the
procedure for this is strictly regulated. Thus, employees are required to
agree in writing to work overtime and cannot work more than four
extra hours on any two consecutive working days and the total number
of hours overtime cannot exceed 120 hours per year. Overtime pay is
set at time and a half for the first two hours and double time for each
subsequent hour.
The minimum statutory paid holiday entitlement is 28 calendar
days, although longer periods are possible by agreement.
Compensation for unused holidays will only apply to those holiday
days in excess of 28. Finally, note that an employee is generally only
entitled to holiday after serving a minimum of six months in the firm,
though a shorter period may be agreed upon by the parties. Vacations
may be divided into several periods but one part per year may not be
less than 14 consecutive days. The Code provides for mandatory extra
vacations for employees working in certain industries and for those
with no fixed working hours.
Minimum statutory wage and currency

control issues
The minimum salary must be no less than the minimum subsistence
level established by the federal legislation (currently the minimum
subsistence level is approximately $80 per quarter, although legislation sets out a minimum salary level of $20 per month). The Labour
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Code provides that a salary must be paid at least twice a month,

although it does not specify whether these payments should be of equal
amounts. Salaries should be paid in Russian roubles by bank transfer
to the employees account or in cash. Payment in foreign currency is not
permitted, although salary levels may be fixed in foreign currency or
by reference to a foreign currency amount. Some banks offer payment
schemes that allow employees to convert rouble salary payments into
dollar deposits or even, in the case of representative office employees,
to receive dollar salary payments on employees credit cards. Salaries
may be a fixed amount per month or may be linked to performance. Any
changes to salary should be notified to the employee at least two
months in advance of the change coming into effect and the change
should be agreed in writing. Employers who pay late may face fines on
the due but unpaid amount for each day the payment of wages is
delayed. If wages are delayed for more than 15 days, employees may
stop working until the wages are paid in full.
Termination of employment agreement

An employment agreement may be terminated with the mutual
consent of the employer and the employee; at the initiative of one or
other party; or upon the effluxion of time.
If it was entered into for an indefinite period of time, an employee
may terminate his employment agreement by giving two weeks notice
to the employer. Any longer period of notice required by the employer
and specified in the agreement will not be capable of enforcement.
Post-termination restrictive covenants are also largely unenforceable.
An employers ability to terminate an employees contract of
employment is severely limited by the Labour Code. The grounds for
termination include:
liquidation of the employer;
redundancy (for specific economic or technical reasons);
lack of qualification (this does not extend to poor performance) or
poor health of the employee;
repeated and systematic breach of duty after disciplinary action has
already been taken;
absence from work for more than four hours without a valid reason;
intoxication (alcohol or drug): this must be medically verified;
committing theft at the workplace and the theft having been
confirmed by the court or an appropriate state authority;
unauthorized disclosure of confidential information.
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Employment contracts with members of the executive body of a legal

entity may also be terminated in accordance with the grounds provided
in those contracts.
The change of ownership of a legal entity may not result in the
termination of its employees labour contracts. The new owner may,
however, terminate the employment contracts of the head of the
company, his deputies and the chief accountant within three months of
the change of ownership.
In each case care must be taken to comply with the strict procedural
requirements of the Labour Code and due regard given to the priority
rights granted to certain groups of employees. For example, the
employment of pregnant women and women with young children may
only be terminated if the employer is to be liquidated. Working students,
war veterans and employees with more than two dependants have priority
to remain employed in cases of redundancy. Decisions must be carefully
documented and, in certain cases, an employee should be offered alternative employment within the organization. Compensation for dismissal
will be payable in an amount equal to between two weeks and five months
salary. Compensation for any untaken holiday is also to be paid.
If the provisions of the Labour Code are not followed when
dismissing an employee or employees then the employee may bring
legal proceedings. Among the various rulings that the court can give is
that of reinstatement, a ruling that is not uncommon.
Data protection
An employer is obliged to protect the personal data of employees that is
in his possession and may disclose such data to third persons only with
the prior written consent of the employee. The employer must also
develop internal procedures for safeguarding employees personal data
and notify each employee of such internal procedures.
Work permits for expatriates

Russian companies that wish to employ foreign labour in Russia must
apply for a general permit to do so. General permits are issued by the
regional divisions of the Federal Migration Service and are valid for
one year; they may be extended on request. For each individual foreign
national, a Russian company requires a Confirmation of the right to
work which is, in effect, a personal work permit. Certain categories of
employees are not covered by these requirements, including employees
of foreign embassies, scientists and artists working in institutions
established in accordance with international agreements, journalists
accredited in Russia, ships crew and students on study internships.
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As work permits are not issued centrally by the Ministry of Ethnic

and Migration Policy, the exact terms and conditions thereof tend to
vary from region to region. In Moscow, for example, the processing of a
work permit usually takes between 24 months.
The procedure of obtaining a work permit in Moscow for a foreign
employee can be split into three stages:
1. Initially the authorization of the local employment authorities must
be obtained. In Moscow this authority is a local branch of the
Employment Board, which is responsible for issuing opinions on
whether it is reasonable for a Russian employer to hire foreign
nationals. It performs a formal check to confirm whether there are
any Russian citizens with the same educational background and
work experience as the foreign national who has been proposed for a
specific position.
2. The second stage is for an employer to obtain a permit to employ
foreign nationals. This permit is issued by the Federal Migration
Service. The applicant must attach its constitutional documents to
the application.
3. The last stage is to obtain a work permit for the employee. The work
permit is issued by the Migration Department of the Ministry for
the Internal Affairs of the Russian Federation.
Personal accreditation of foreign employees of

representative offices
Individuals employed by the representative offices of foreign
companies may apply to the registration body where the representative office is accredited for their own personal accreditation. For
example, the State Registration Chamber will accredit a representative office and usually will allow that representative office to accredit
up to five individuals. On application this number may be increased.
Personal accreditation confirms the official status of a representative offices employee and allows an accredited person to obtain a
visa with less difficulty than a non-accredited person. Family members
of employees may also be granted personal accreditation. The validity
of the personal accreditation is linked to the term of accreditation of
the representative office, so the personal accreditation may be
extended only after the accreditation of the representative office of a
foreign company has been extended.
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Visas
As well as a personal work permit or personal accreditation, a foreign
employee may require a visa to enter, remain in and leave Russia.
Registrations with the Ministry of Interior

Foreign employees of Russian companies and their representative
offices in Russia must register with the Department for Visas and
Registrations of the Ministry of Interior (UVIR). Foreign nationals
visiting Russia must register their passports and visa with the UVIR
within three days of arriving in Russia. If the foreigner is staying at a
hotel, the hotel will usually organize registration with UVIR, but if not,
then registration is still required. UVIR will place a stamp in the visa
to confirm registration. A foreign national without this stamp is likely
to encounter difficulty with the militia and other authorities.
5.6
An Investment Project in
Russia: Applicable Laws
Andrey Goltsblat, Managing Partner,
The following chapter is designed to take the reader through the basic
stages that an investor may want to consider when formulating their
business strategy for the Russian market. In summary, these stages,
and the elements of a structured investment strategy that potential
businessmen may want to consider for Russia, include the following:
basic stages of an investment project (direct investment);
land legislation;
corporate law;
investments tax allowances;
Russias international treaties;
customs allowances for investments;
foreign investment law.
We will take the reader through each of these components of an
investment strategy point by point.
Stages of an investment project in Russia

Below is an approximate outline of an investment project/
construction/reconstruction of manufacturing facilities in Russia.
Stage 1: Establishment of a Russian legal entity

One month. This stage includes:
producing a charter and other necessary corporate documents;
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building up charter capital;

registration of the legal entity with tax authorities, state funds,
state statistic committee, and other authorities;
opening of bank accounts.
Stage 2: Work permits for foreign personnel

Three to six months; may be implemented simultaneously with stages
310. If required, permits are issued by the Interior Ministry.
Stage 3: Selection of a land plot

One to four months; may be implemented simultaneously with stages
12 or even before stage 1. This stage includes conclusion of a contract
with a professional realtor company.
Stage 4: Acquisition of a land plot

Three to seven months. Possible options are lease or purchase of the
selected site (generally green-field or brown-field sites).
This stage includes various actions depending on the category
and/or location of a particular site, for example:
due diligence;
boundary marking and cadastre registration of a land plot,
change of category of the site (for all non-industrial lands), this may
be accompanied by statutory crop losses compensation and negotiable compensation for losses incurred by land users;
negotiating the transaction terms;
conclusion of a purchase or lease contract;
state registration of title to the site or the right to lease it (purchase
or lease).
Land plots may be acquired both from the state/municipalities and
from private persons.
From the state/municipalities land plots are normally acquired in
two ways:
1. Upon prior approval for the location of the facility [to be constructed]
which includes:
filing an application for land plot selection with the state or
municipal authorities;
selection of a land plot by the municipal authorities and issuance of
a relevant act and a decision on prior approval for the location of the
facility;
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demarcation of the boundaries of the land plot and its cadastral

registration;
adoption of a decision by the state or municipal authorities to lease
out the land plot;
reimbursement of losses incurred by the holders of rights to land
plots (if it is necessary to withdraw the land plots);
signing and state registration of a land lease.
2. Without prior approval for the location of the facility, which includes:
completion of formalities for the land plot by and at the expense of
the governmental authorities;
decision of the state or municipal authorities to hold bidding
(tenders, auctions) and publication of a relevant announcement;
filing an application to participate in the bidding;
holding the bidding for the sale of the land plot or the right to enter
into a lease thereof;
signing and state registration of the sale and purchase agreement or
the lease of the land plot.
The acquisition of land plots from private persons (individuals or legal
entities who own land plots) normally includes:
due diligence review of documents evidencing the rights to a
particular land plot and corporate documents of the right holder;
obtaining various certificates and opinions from the state and
municipal authorities concerning the legal status of the land plot
and the options to use it;
acquisition of the land plot through the execution of a sale and purchase
agreement (or a lease), purchase of shares or ownership interests in the
legal entity or otherwise depending on the circumstances;
state registration of the right to the land plot.
The acquisition of land plots both from the State and from private
persons may require a change of land category and compensation for
crop losses (eg conversion of agricultural lands into industrial ones) or
forest losses (eg conversion of forest fund lands).
Stage 5: Development of necessary pre-project

documentation
Five to eleven months. This stage includes:
development of town-planning documentation and getting it
approved by state and municipal authorities;
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obtaining Technical Conditions for using municipal electricity, gas,

water, waste water treatment plant and other resources;
obtaining a construction permit (crucial state permission is
necessary for nearly all types of construction operations); etc.
Stage 6: Development of design documentation

A design project includes various types of documents (eg Feasibility
Study {abbreviated in Russian to TEO}, working project, etc)
depending on the purpose, function and technical characteristics of the
facility to be erected.
This stage includes:
choosing a designing company and conclusion of a contract for development of design documentation;
obtaining official approvals for design documentation (for instance,
ecology experts, Fire Inspectorate, architecture authorities etc);
obtaining a favourable governmental expert opinion on project documentation and environmental impact of the project, etc.
Stage 7: Construction
Six to ten months. This stage includes:
obtaining a municipal construction permit;
choosing a General Contractor and conclusion of a general
construction contract;
supervision over construction operations;
preliminary acceptance of the facility erected and elimination of
discovered construction drawbacks.
Stage 8: Import or purchase and installation of

production machinery
Two to five months; as a rule this is implemented simultaneously with
stage 7. This stage may include:
conclusion of import and installation contracts;
customs clearance of imported machinery (imported technological
machinery is, under certain circumstances, exempt from VAT and
customs duties);
installation of machinery; etc.
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Stage 9: Final official acceptance of erected facility by

state accepting commission
One month. This is a crucial act, which is necessary for commissioning
the facility erected and future registration of title. An official acceptance report is followed by an appropriate Mayors Resolution.
Stage 10: Registration of title to facilities, buildings,

constructions
One to three months. As a result, title is confirmed by an entry in the
State Realty Registry and an Ownership Certificate.
Total: 2030 months
Land relations under investment projects

Choice of a land plot, title examination
Circulation of non-agricultural privately-owned lands:
purchase and sale;
lease (term is not limited, except for agricultural lands whose lease
term is 49 years);
mortgage;
contribution to the charter capital.
Circulation of non-agricultural state- and municipally owned lands:
lease (term 49 years);
privatization;
perpetual (indefinite) use.
Provision of land plots for construction purposes

Restrictions on foreign ownership of land plots:
purchase and sale of a land plot out of agricultural lands;
lease of land plots out of agricultural lands;
privatization or lease of agricultural state- or municipally-owned
lands;
circulation of ownership interests in the common property;
special considerations relating to the use of farm lands for
constructing industrial facilities;
land categorization, change of category;
compensation for crop losses and forestry losses.
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Investment projects in terms of corporate law

An investment project normally presupposes one or another corporate
structure and registration of a Russian legal entity.
Such legal entities are most commonly set up as a limited liability
company (abbreviated in Russian to OOO) and a closed joint-stock
company (abbreviated in Russian to ZAO).
When choosing a legal status for the company, the main consideration to be taken into account is the number of investors/participants,
whether they are associated entities or not, and whether a joint
venture is planned to be set up. If a foreign legal entity sets up, directly
or through a group of entities, a company in Russia that is fully owned
by such legal entity, the most suitable legal status for the company will
be OOO. An OOO gives an opportunity to promptly increase its charter
capital, while with a ZAO registration of the issue of shares will be
required and the issuing company, in case of any additional issue of
shares (ie with the exception of the initial issue of shares at the time
when the company is established), will incur a securities trading tax
liability. An OOO is easier to manage than a ZAO. In relation to the
establishment and operation of an OOO (except where the OOO
decides to issue bonds), unlike for a joint stock company, there is no
Federal Commission on the Securities Market as an additional supervisory body over OOOs.
When a joint venture is planned to be set up, the choice of legal
status may depend on the prospective ownership interest of a
particular investor and the availability of a sufficient number of discretionary rules in the laws concerning those provisions of foundation
documents which relate to decision-making. Another argument in
favour of an OOO is the possibility for any of its members to secede
from the company. During six months of the year following the year in
which an application for secession was filed, the seceding member
should be paid the actual value of his ownership interest as of the end
of the fiscal year in which the application was filed.
Apart from choosing a legal status, of great importance is the establishment of branches and representative offices. More often than not
regional authorities insist that a new legal entity be set up in the
region where a particular investment project is being carried out, even
if in another region there is already a legal entity (involved in this
project). They believe that by doing this, more taxes will be paid to the
budget of the appropriate constituent entity of the Russian Federation,
but this is not true.
In tax terms, due to the impossibility for a holding company to make
consolidated tax payments, it is beyond any doubt more advantageous
to set up a branch. It is also possible to open a representative office or a
detached subdivision. However, the presence of a branch makes it
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easier to handle customs formalities in the region and does not affect
payment of taxes into the budget of that region.
Investment tax allowances

Russian laws currently offer practically no essential investment tax
allowances and those that were previously available are now
suspended. For example, in Moscow Oblast in 2003 investment
allowances were suspended.
The only investment allowances that are available now are those
that can be obtained from local governments. Local authorities are
empowered to offer a property tax allowance and an allowance in
relation to advertising tax, which is a tax on costs.
Russias international treaties

Some of the international treaties to which Russia is a party contain
provisions allowing a reduction of the tax burden for a Russian
company where an ownership interest is held by an investor originating from a country that is a party to a relevant treaty.
A good example is the Double Taxation Agreement between Russia
and Germany. According to the Additional Protocol to this Agreement,
advertising costs incurred by a company with German participation
are fully deductible for profit tax purposes. Although the new version of
chapter 25 of the Russian Tax Code allows the deduction of basic advertising expenses from the profit tax base, large FMCG companies still
end up with huge advertising expenses associated, for instance, with
promotional campaigns that are treated by the law as a promotional
sweepstake, the costs of which continue to be treated as non-deductible
for profit tax purposes.
Investment allowances for customs payments

Customs allowances for the importation of goods
Goods that are imported as a foreign investors contribution to the
charter capital of a company with foreign participation are exempt
from import duty if these goods:
1. are not excisable;
2. can be categorized as fixed assets;
3. are imported within the time limits set by the foundation documents
for charter capital build-up.
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1. The goods should not be excisable.

The list of excisable goods is set out in part two of the Russian Tax
Code.
2. The goods should fall under the category of fixed assets.
For categorizing instruments of labour as non-current (fixed) assets,
the criterion of their circulation (service life) is applied, while the value
criterion is not used. Thus, it makes no difference how the goods
imported as a contribution to the charter capital are assessed by the
investor in terms of their value.
3. The goods should be imported within the time limits set by the
foundation documents for building up the companys charter capital.
Tariff benefits are offered only if the goods were imported into the
customs territory of Russia and declared as goods imported as a contribution from a foreign founding member into the charter capital of a
company with foreign participation before the expiration of the
deadline for charter capital build-up set by the companys foundation
documents or Russian laws.
A customs allowance may be provided either in the form of
exemption from customs duty or refund (off-set) of customs duties paid
earlier. Everything depends on the availability of the list of imported
property. If such a list is known, the customs allowance will be granted
in the form of an exemption. However, under certain circumstances
this procedure is more complicated, because it requires a classification
decision from the State Customs Committee of Russia.
VAT allowance
Art. 150 of the Russian Tax Code Non-Taxable (Tax-Exempt)
Importation of Goods into the Territory of the Russian Federation
treats as non-taxable (tax-exempt) manufacturing equipment, and
components and spare parts for such equipment imported as contributions to the charter capital of companies.
Foreign investment law

The Foreign Investment Law does not contain any fundamental provisions that would, one way or another, regulate foreign investments.
This Law declares the principle of equal treatment for foreign
investors and Russian investors. The Law stipulates guarantees for
foreign investors, which are of rather a declarative nature. The Law
provides that a foreign investor or its company in Russia will be
protected against unfavourable consequences of newly adopted tax or
customs legislation (for not more than seven years). At the same time
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this protection is only afforded to priority projects, the list of which is to

be approved by the Russian Government. We are not aware of any such
projects. Neither are we aware of how this legal provision is applied.
Thus, the Law offers no practical help either for the implementation of
investment projects or for the protection of investors interests,
although it does confirm that both investors and companies with
foreign capital are being treated in a civilized manner.
5.7
Entrepreneurial
Start-ups
Jamison Firestone, Firestone Duncan
Most entrepreneurial start-ups in Russia will be what Western countries define as small businesses businesses with anywhere from
thousands to several millions of dollars of investment. These businesses are typically owned by small groups of people with limited
resources to invest in the start-up, although at times they can also be
the local operations of large multinational corporations. While this
chapter should prove useful to the latter, it is directed at the former as
a guide to the nuts and bolts of starting an entrepreneurial venture
in Russia.
Setting up a venture
Planning the structure
Russian law is neither intuitive nor forgiving. What seems like a
straightforward contract in the US or the UK most likely will not be
enforceable in Russia. What seems like a simple way to operate might
have very unfavourable tax or legal consequences for a company operating in Russia. In short, proper planning with legal and tax advisors
who specialize in Russian law is essential before registering a company
or even concluding a seemingly simple contract.
The first issue that needs to be determined is the structure of operations. This not only includes choosing the correct form of legal entity to
register in Russia but also determining how that entity will be owned
and how it will contract with suppliers and with clients.
Many issues will be taken into consideration at this time, including
the ability of the various types of legal entities to carry out the business
as envisioned, Russian hard currency control legislation, Russian
taxation, and how best to protect the rights of the various shareholders
if there are going to be several shareholders in the venture.
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Application of the simplified taxation system for small businesses

One of the first issues that should be considered at this time is the
possible application of the simplified taxation system for the company.
The present simplified taxation system was introduced by the
Federal Law No. 104-FZ of 24 July 2002, and is a special system that
can only be used by small businesses and individual entrepreneurs.
The system allows legal entities and individual entrepreneurs to
replace the obligation to pay a number of significant taxes (corporate
profit tax, VAT, assets tax, unified social tax and tax on income from the
entrepreneurial activities) with a single unified tax.
The unified tax under the simplified taxation system is chosen by
the taxpayer as either 6 per cent of turnover or 15 per cent of the
difference between revenues and certain allowable expenses.
The simplified taxation system is intended for small business and
therefore there are certain restrictions that prevent larger companies
from using the system. The system cannot be used by:
companies and entrepreneurs earning more than 15 million roubles
(about $525,000 at the time of writing) of income during a calendar
year;
companies having branch offices and/or more than 25 per cent
corporate ownership;
companies and entrepreneurs engaged in certain activities
(banking, insurance, gambling, and some other businesses);
companies and entrepreneurs employing more than 100 employees;
companies having amortized assets worth more than 100 million
roubles (about $3,500,000);
other companies and entrepreneurs meeting some specific criteria.
It should be noted that Russian accounting requirements are very
demanding and time consuming. They often require a large number of
forms to be completed and filed even if the company is not conducting any
business. Often these forms must be filed in person by a company
employee and this can mean waiting in line outside the tax office for hours.
For this reason, simplified accounting and reduced tax filing requirements
are often a bigger bonus to small businesses than reduced taxation!
Although the limits placed upon turnover and the limits placed upon
corporate ownership effectively limit the application of small business
tax preferences to the very smallest of small businesses, the benefits of
the system are significant enough that any business that could be
structured to use these benefits should seriously consider doing so.
It is important to note that at the time of writing this chapter, the
Russian Government is seriously considering expanding the definition
of companies and entrepreneurs that will qualify to use the simplified
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taxation system. It is anticipated that a new definition would vastly

raise the turnover limits and might remove the corporate ownership
limitation.
Therefore, when planning a start-up in Russia it will be important to
see if the current simplified taxation regime could be applied to the
venture in question. If it could be applied based on turnover but not
based on corporate ownership, it may be appropriate to consider
whether the very real advantages offered by the legislation are worth
the individual owners holding a Russian company directly.
One very important point to keep in mind: a company wishing to use
the simplified system of taxation for small businesses must notify the
tax authorities of this simultaneously with the registration of the
company or between 1 October and 30 November of the year preceding
a new calendar year where the company wishes to switch to the
simplified system. It is not possible to start using the system in any
other fashion.
Implementing business registration

The legal address of the business
Chapter 18, Article 288 point 3 of the Russian Civil Code requires that
the business has a non-residential address. Furthermore, this address
must be given to the tax authorities before the company can be registered. Legally the address must be the actual non-residential address
of the executive body of the business. This means that compliance with
the law demands that a business find premises first before being registered. While it is possible to buy a fake business address and while this
is often done for start-ups that do not yet have a place of operation, the
management of the company is risking criminal liability by doing this.
Buying a ready-made company vs registering one from scratch
Registering a company in Russia to a foreigner or a foreign corporation
takes about three weeks from the time the process is started until the
company is fully operational. However the process cannot be started
for foreign citizens or foreign companies that will participate in
Russian companies until they produce certain documents. In the case
of foreign citizens who will not come to Russia to appear before a
Russian notary or in the case of foreign corporations, those documents
will have to be apostilled in the home country, a process that can take a
bit of time. Due to the length of the entire procedure many foreigners
often consider buying ready-made companies. Although buying a
ready-made company can at times be a way to get into business
quickly, the time savings are more often than not illusory.
Furthermore, there are several things that buyers should be aware of.
Part of the reason it takes so long to register ownership of Russian
companies to foreign citizens and foreign companies is because they
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often must provide apostilled documents from abroad. If these documents are not on hand there is no way to put a ready-made company
under the control of the foreign citizens or foreign corporations that
wish to buy it. While some people will choose to put the business under
the temporary control of a local person, this is generally not a prudent
thing to do. Even if the proper documents are on hand the amount of
time it will take to transfer a ready-made company to the buyer and to
open bank accounts in a decent bank is roughly equivalent to the time
it will take to set up a new company. For this reason there is often little
reason to buy a ready-made company.
Furthermore there are significant risks in buying ready-made
companies. In the overwhelming number of cases the companies have
never been used and have no liabilities but they often have technical
defects that make them dangerous to use.
The two most common defects are:
Company transferred to new owner before capital has been paid in
Almost all ready-made companies are capitalized upon their
formation with equipment that in fact does not exist (which means
that the charter capital has never paid in). If the company is transferred without first paying in the capital, the company is subject to
liquidation. This is a principal defect that can never be remedied.
While the Russian authorities are not out to find such companies, it
would be risky in the extreme to entrust significant assets to such a
business because this defect could always be used as a reason for the
authorities to liquidate the business. Often it is possible to prepare a
ready-made company for a clean sale by having the buyer of the
ready-made company buy the fictitious equipment from the readymade company and pay the purchase price to the company. After this
has been done the company can then be transferred to the buyers
ownership.
Company charters are poorly written
The charters of most ready-made companies are very crude and tend
to have a lot of passages that say things like to be resolved in accordance with the law. In other words, if there is to be more than one
shareholder, the charter will need substantial revision to protect the
interests of the shareholders.
Operational issues
Once the overall structure is clear and once company registrations are
underway, there are many legal and tax issues that need to be resolved
that relate to overall operations. Some of the most important ones are
listed below.
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Hiring a full-time or part-time Chief Accountant and the

qualifications necessary
Most operative Russian companies will require a full-time Chief
Accountant. This is not a legal requirement, it is a practical
requirement. The volume of accounting work and the intricacies of
Russian tax law usually require a full-time in-house person if the
company is to operate effectively. Once again, Russian accounting is
not intuitive. It is designed to help tax inspectors collect as much tax as
possible, it is not designed to be a financial tool that allows managers to
gauge the health of a business. For this reason it is often possible to
owe tax even when a business is losing money.
Three things to consider are:
1. How many people are issuing or collecting source documents?
Source documents are the documents that form the basis for
accounting such as invoices, dispatch notes, expense reports, bank
and petty cash payment orders, receipts for expenses etc. When
more than one person in the company generates all these documents, the company has generally grown to the point where a parttime or outsourced accountant will not be a good solution.
2. Almost any company will save money if its accountant is very knowledgeable regarding tax law and is proactive. This is the difference
between hiring a bookkeeper and a specialist as Chief Accountant.
A bookkeeper will file all accounting statements correctly and
inform company management after the fact that they have a large
tax bill to pay, often when the company has not made any profits. A
knowledgeable proactive Chief Accountant will understand the tax
and accounting issues that arise from the way a company is operating and will often be able to find a legal way of structuring transactions and accounting for them that will not result in punitive
taxation. This type of proactivity can only be carried out by a knowledgeable accountant who is familiar with the day-to-day operations
of the company and who is on site often enough to take corrective
action before a problem arises.
3. Management must be able to speak directly to the Chief Accountant.
Although it is possible to use a translator to speak with your
accountant, it is not advisable. If you cant speak Russian, it is
almost always worth paying more for a skilled chief accountant who
can speak your language.
Hiring Russian staff: Employees vs independent

contractors
Russian employment law is not very favourable to the employer. The
old labour legislation was designed for Soviet times when everyone was
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guaranteed a job with the State and if the State fired you it was often
impossible to find another job. Although the new Labour Code, which
was made effective as of 1 February 2002, is a progressive change, it is
still targeted at protecting primarily the interests of the employee, not
of the employer.
For the most part an employer can have a three-month trial period,
during which it is relatively easy to dismiss the employee; after this it
is very difficult (but often not impossible) to dismiss an employee who
refuses to accept being fired. Even if there is no contract but the
employee can prove that he worked for the company, Russian
employment law will apply. Furthermore, there are also significant
payroll taxes associated with paying employees.
One way that small businesses can get around unfavourable labour
regulations and high payroll taxes is to contract staff as contractors
and not as employees, and for those contractors to use the simplified
system of taxation. In this case there are no payroll taxes, the staff s
personal taxes are reduced by half, the relationship does not fall under
Russian labour law, and therefore it can be terminated at any time.
Working with independent contractors presents some difficulties. In
Russia it is still a criminal offense for a person to work as an independent contractor without first officially registering as an independent entrepreneur. Although this registration is not difficult, it
must be done in the city where the worker is registered to live (which
may be a different city to where he actually lives and works) and the
worker must then file and pay taxes quarterly instead of having everything done for him by the company. Often the company will assume the
responsibility for preparing and filing the tax returns but the worker
must still pay his own tax. One further difficulty is that only Russian
citizens or foreigners with residency permits can register as individual
entrepreneurs.
Visas and work permits for foreigners working in Russia

Foreign citizens who work in Russia for a company registered in Russia
require either a work permit or a work visa from the company they will
work for, or a residency permit. The process of arranging a work permit
and work visa or a residency permit will take four to six months.
Working in Russia for a company registered or accredited in Russia
without such documentation is a violation of the law and can result in
deportation. Furthermore, two administrative violations are now
grounds for refusal to issue a Russian visa.
In the past foreigners setting up a new Russian venture would often
order a one-year commercial multi-entry/exit visa from a travel service
provider and then they would begin working for their new venture.
Today it is clear that this practice is illegal and could result in the
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foreigner being deported or denied visa renewals. While ordering such

a visa may be a good way to initially enter and leave Russia during the
start-up phase of the business, it is completely inappropriate if the
foreigner wishes to work for that company.
Thus, it is important that foreign citizens assume no official positions in their Russian businesses until such time as they have obtained
a Russian work permit and work visa or a residency permit. It should
be noted that while in the past work visas and residency permits did
not grant the right of exit (a foreigner had to apply for an exit visa a
week to two weeks ahead of any planned exits!), this problem seems to
have been recently resolved for work visas. Since January 2004 work
visas have been issued as multi-entry/exit. The situation with residency permits is still unclear at the time of writing.
Conclusion
Although Russian regulations do not make it quick, cheap or easy to
establish and maintain entrepreneurial ventures, a little advance
knowledge of the issues facing entrepreneurial start-ups can go a long
way to avoiding problems later on. Knowledge combined with
prudence, a rapidly growing economy and an abundance of opportunities ensures that many entrepreneurial ventures will be well worth
the effort.
5.8
Property Rights
Andrei Soukhomlinov, Partner, Baker &
McKenzie CIS, Limited
Introduction
Both the Constitution of the Russian Federation and the Civil Code of
the Russian Federation uphold the right to own private property. The
Land Code of October 2001 and other federal laws adopted as a followup to the Land Code are another important step ensuring that this
policy becomes a reality.
President Vladimir Putin and the Government of the Russian
Federation have always recognized the importance of statutory regulation of the status of land. As a result, the Land Code was adopted by
the State Duma, approved by the Federation Council, and signed by
the President on 25 October 2001. As provided in the Federal Law On
Implementation of the Land Code No. 137 FZ of 25 October 2001 (the
Implementing Law), the Land Code came into force on the date of its
publication, 30 October 2001. The Land Code, together with the
Federal Law No. 101-FZ On Circulation of Agricultural Lands of 24
July 2002 (the Circulation Law), which entered into force in January
2003, put an end to the political debate as to whether land ownership
in Russia is possible.
At the present time, land is treated separately from buildings under
Russian law, although there are plans to develop a concept of a single
object of real estate on the basis of the rights to land. The Land Code sets
out the principle of a single approach to land and buildings that are
located on such land. The implementation of this principle will, however,
require further extensive changes in the existing laws and regulations.
Under current Russian law, investors have choices in terms of using,
leasing, and owning property. In addition, Russias recent economic
growth has introduced new opportunities to those investors that are
interested in participating in the Russian real estate market. However,
in looking at these details, it is important to understand that there are,
for the moment, different regulations for land and for buildings.
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Ownership of land
The general principles of land ownership are set forth in the
Constitution of the Russian Federation, which was adopted in
December 1993. Article 9 of the Constitution proclaims the principle of
private ownership of land, but does not, however, stipulate the
procedure for the transfer of land (which had historically been owned
by the State) into private ownership. This legislative vacuum has
prompted the rise of a number of regional laws and regulations, as well
as the Presidential Decrees adopted in an attempt to regulate various
land issues. Regional initiatives raised, however, a more serious
concern with respect to the overall validity of all of the regional laws on
land ownership. According to Article 72 of the Constitution, decisions
on issues on the possession, use and disposal of land are the joint
responsibility of the Federation and its subjects (constituent
members). Article 76 of the Constitution further provides that a federal
law must govern such issues of joint responsibility. Such federal law
may be supplemented by laws and other regulations that the subjects
of the Federation may issue in compliance with the federal law in
question. In addition, Article 36 of the Constitution provides that a
federal law must determine the terms and procedures of land use.
The Land Code therefore represented a significant reform, particularly because of the federal sanctions and encouragement that it gives
to the creation of private ownership rights in land. Although fundamental terms and procedures of land use are determined in the Land
Code, it provides that other Federal laws will have to be adopted. The
Land Code has limited applicability to agricultural land, as it is
expressly provided that the circulation of such land is the subject of a
separate Federal law.
Possession, use and disposal of land plots designated for agricultural
use are regulated by the Circulation Law. Not all agricultural land,
however, is subject to the Circulation Law. It does not extend, for example,
to those land plots that were provided to individuals for the construction
of individual homes or garages, or for carrying on a small-holding or
dacha garden. Such land plots are covered by the provisions of the Land
Code. Agricultural land plots may be held by right of ownership,
perpetual (indefinite) use, lifelong inheritable possession, or free fixedterm use, and such plots may also be leased. Ownership of land plots in
state or municipal ownership is to be awarded to individuals and legal
entities, as a rule, through bidding by tender or auction. Such bidding is
also to be held during such land plots lease when they are claimed by two
or more potential lessees. The way the corresponding tenders or auctions
should be organized is described in Article 38 of the Land Code.
Although there is no express provision permitting land ownership
by foreigners, the Land Code may clearly be interpreted as allowing
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such ownership, except in cases where it is specifically prohibited. The

rights to acquire land ownership rights under existing buildings or for
construction are equally applicable to foreigners subject to the
following restrictions set out in the Land Code:
1. The relevant rights must always be paid for and can never be
granted free of charge; and
2. Foreigners are specifically prohibited from owning land plots in
border areas, a list of which is to be drawn up by the President, or in
other special territories of the Russian Federation pursuant to other
federal laws. Additionally, the President may establish a list of types
of buildings and other structures to which pre-emptive buy-out or
lease rights to land plots for foreigners may not apply. Under the
Implementing Law and pending the preparation of the Presidential
list, the border restrictions apply to all border areas. Foreigners are
also prohibited from owning agricultural land. The Circulation Law
further specifies the rights to agricultural land that may be granted
to foreign nationals and foreign legal entities (and stateless
persons). Those in this category may only lease agricultural land
plots. This restriction on foreign legal entities also extends to
Russian legal entities in which the equity participation of foreign
nationals, foreign legal entities, and/or stateless persons exceeds
50 per cent. Pursuant to recent amendments to the Federal Law On
Mortgages (Real Property Pledges), it may now be possible for
foreigners to mortgage certain categories of agricultural land.
Mortgage rights do not, however, automatically entail ownership
rights.
Under the Land Code, the rights to land now consist of ownership (by
the State, municipalities, private individuals, and legal entities),
perpetual or indefinite use, free fixed-term use, lease, lifelong inheritable possession, and easements.
In the future, new rights of perpetual or indefinite use may only be
granted to state and municipal institutions, Federal Treasury-owned
enterprises, and state and local authorities. Legal entities (other than
those listed in the previous sentence) with existing rights of perpetual
use will no longer be able to transfer these rights. Under the terms of
the Implementing Law, these entities had until 1 January 2004 to
convert and re-register their rights as (at their option) either lease or
ownership rights. Recently, the term for conversion of the rights as
either lease or ownership was extended until 1 January 2006 in accordance with Federal Law No. 160-FZ of 3 December 2003. Presently, any
legal entity looking to transfer its land rights to another legal entity,
such as a joint venture, will first need to upgrade its rights accordingly
before any contributions can be made.
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The Land Code sets out detailed procedures for acquiring rights
over land that is intended for new construction. In particular, the Land
Code distinguishes two scenarios. Under the first, a land plot must first
have been prepared for sale or lease: its boundaries defined; a
cadastral number (a special number assigned to land plots indicating
their area, location, type category, etc) assigned; and technical conditions for the utilities connections determined. In such cases the Land
Code provides either for acquisition of land directly into private
ownership or for lease.
The second scenario for the allocation of land for construction
purposes will be used when a new project will require a thorough
investigation of ecological, sanitary, architectural, and other issues,
and a specific request for land rights from an investor. This may
involve the investigation of public opinion regarding construction in
the area. In such cases no tender is required. The land will, however, be
given on lease only.
Of particular interest to owners of existing buildings and structures is
an option to privatize or to obtain land lease rights over the land plots on
which their buildings are located, where such land plots are owned by
the State or a municipality. Owners of existing buildings, facilities or
structures located on land owned by a third party will now enjoy the preemptive right to purchase or lease the land plot beneath such buildings.
Ownership of buildings
The current Russian law permits both Russian and foreign nationals
and legal entities to own buildings. In general, the rules relating to the
use, disposal and sale of buildings are set forth in the Russian Civil
Code, which guarantees the freedom to sell, rent, and carry out other
transactions with buildings. The process of the acquisition of buildings
through privatization is also less complicated. In general, provided
that the building in question was recorded on the balance sheet of the
state enterprise at the time it was privatized, the successor company
has the right to own that building.
In the past, state-owned buildings were granted to state-owned
enterprises for economic management or use. During privatization,
however, such buildings and other structures were usually transferred
into the ownership of those enterprises that operated and used them
on the basis of various use rights. Thus, the newly privatized enterprise would inherit such buildings and structures from the stateowned enterprise, provided that they were recorded on the companys
balance sheet and were included in the privatization documentation.
The special authority that is in charge of the state registration of the
rights to real estate must issue an ownership certificate certifying the
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right of ownership of buildings and structures (see section below). In

accordance with the Civil Code, the rights to real estate arise after the
state registration of such rights, except in the case where such rights
have been obtained prior to the adoption of Federal Law No. 122-FZ of
21 July 1997, On State Registration of Real Property Rights and Real
Property Transactions, as amended (the Registration Law). In this
case, the owner is not obligated to register the rights unless it wants to
enter into any transaction related to the real estate object. Obtaining
the relevant certificate is a fairly straightforward, although sometimes
lengthy, process, as long as the private company that is seeking to
obtain such a certificate can clearly demonstrate that the buildings in
question were purchased or privatized in accordance with the
prescribed procedures. Before an ownership certificate is issued, the
local office of the Bureau of Technical Inventory (BTI) needs to carry
out a detailed assessment of the building and to produce an updated
BTI technical passport for the building. Quite often, this becomes a
problem since no such updated BTI technical passport exists and
building owners are often reluctant to incur the costs involved in
securing the required BTI assessment.
Leases
Foreign legal entities may be granted either land leases or building
leases. Such leases on state- or municipally-owned property are
usually based on a standard local form. Although the Civil Code does
not stipulate a statutory maximum length of time, the current practice
is that such lease terms rarely exceed 49 years.
However, in Moscow the recently adopted Moscow City Law No. 27 on
Land Uses and Construction in the City of Moscow of 14 May 2003,
which came into force on 26 June 2003, fixes those periods for which
leases may be obtained for Moscow-owned land plots. Lease terms for
sites free of any capital buildings, structures, or facilities may not exceed
five years. Land plots on which such property is located are, however,
available for leases of 2549 years, confirming existing practice. In some
cases, in extension of current practice, they may even be leased for as
long as 99 years. This will require a Moscow Government decision in
respect of projects of special significance to the city.
The level of rent payments for the majority of land leases granted by
the State or municipalities is set either by a general local decree or by
a specific decree for the lease in question. In Moscow, where the
demand for land remains relatively high, a lessee must pay rent calculated on the basis of a formula. In addition, a Moscow lessee must pay
for the right to lease any land in excess of the area of the existing
building on that land. In St. Petersburg, the level of rent is determined
338
by a decree of the Governor; the levels differ depending on the location

of the site and the type of activity of the lessee, and in some instances,
it is possible to negotiate the lease rent with the local St. Petersburg
authorities.
The basis for granting a lease for a municipal- or state-owned
building, as well as the rental payments, is normally established by a
local decree. The parties themselves may negotiate leases for a part of
or for the entire privately-owned building. To date, few office and retail
sector leases have exceeded a 10-year term; with 5-year terms being
the most common. Longer leases of 25 years or more have been
executed in the industrial sector. All three markets, however, are
changing rapidly. Subleases are also permitted, subject to any
contractual restrictions in the primary lease.
Whether the lease concerns land or a building, the Land and Civil
Codes provide a lessee with certain basic rights. When the property is
transferred, it must be in the condition required by the lease.
Thereafter, unless the lease specifies otherwise, the lessor is liable for
the repair of defects on the premises. If the lessor fails to carry out the
necessary repairs, the lessees options include compensation and the
right to terminate the lease. A lessee that properly fulfills its obligations under the lease has a priority right of renewal at the end of the
term. The renewal rights of a lessee under a land lease are to be treated
in conjunction with the pre-emptive rights to purchase or lease the
land plot that are granted to the owners of the existing buildings and
structures.
Significantly, the provisions of the Civil Code, insofar as they apply
to land leases, are supplemented by the Land Code in a number of
areas. In particular, the Land Code sets forth a series of modified rights
for land lessees. Their applicability will, in part, depend upon the
precise drafting of a lease. For example, the presumption under Article
615 of the Civil Code that a lessee needs a lessors consent to sublease
has been reversed for lessees of land. Of particular significance is the
provision that lessees of state- or municipally-owned land under lease,
with a term exceeding 5 years, now have a free right to assign their
rights, subject only to the delivery of a notice to the lessor. In other land
leases, this rule will also apply (in contrast to the provisions for prior
consent under Article 615(2) of the Civil Code). A notable improvement
is also made in conveyancing procedures, with the new provision that
the assignee of a land lease does not need to enter into a new land
lease.
Both the lessor and the lessee may terminate the lease contract, but
only with a court order. The Civil Code also suggests that the lease
contract may provide for other termination opportunities. Additional
protection is given to the lessees of residential premises. The Land
Code contains new provisions that deal with the termination of land
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leases in conjunction with a court order. Presently the following will

also constitute grounds for termination:
1. misuse of the land plot (a more stringent test than that under Article
619 of the Civil Code, which requires either substantial or repeated
violations);
2. use of the land plot that results in a decline in fertility of agricultural land or, important for industrial users, a material deterioration in the environmental situation;
3. failure to correct a range of other intentional environmental violations of applicable land use regulations; and
4. failure to use the land plot for its designated purpose for a period in
excess of three years.
Most leases must be state-registered to be valid. The only exception is
for leases of buildings for a period of less than one year, which do not
need to be state-registered to be valid. The principles and procedures of
state registration are discussed below.
State registration of rights to immovable property

As discussed above, the right to real estate arises only from its state
registration. The current Russian legislation contains a specific
procedure for the registration and identification of rights (title) to
immovable property. In many cases, such registration is a prerequisite
for the validity and enforceability of transactions involving immovable
property.
According to the Registration Law, transactions involving
immovable property (buildings, land, etc) are also subject to state
registration, and they become effective and enforceable only upon such
registration. The registration authorities in the place where the
immovable property is located carry out the registration process. The
registration authorities maintain the Unified State Register of Rights
to and Transactions With Real Property, which indicates the history
and the current status of the immovable property in question. This
Register also records various encumbrances over immovable property,
including leases. The registration authorities issue a certificate in a
prescribed form that certifies the rights to immovable property.
Information on state-registered transactions with immovable property
is also included in the Register.
Land plots are also required to undergo the cadastral registration.
The procedures and rules of the state cadastral registration of land are
outlined in Federal Law No. 28-FZ On the State Land Cadastre, dated
2 January 2000 (the Land Cadastre Law), which came into force in July
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2000. The State cadastral registration applies to all land plots located
in the Russian Federation, regardless of the form of ownership, the
designation, or the authorized use of the land plots. Under the Land
Code, only land plots that have State cadastral registration can be the
subject matter of a sale-purchase transaction. In practice, especially in
Moscow, this applies to all transactions with land plots. The Unified
State Register of Land (the Land Register) is established pursuant to
the Land Cadastre Law and contains detailed information on land
plots, including their cadastral number, location, land category and
authorized use, the borders of the land plots, the registered proprietary
rights and encumbrances over the land plots, and information about
any immovable property on the land plots. The information from the
Land Register is open to the public. The Land Cadastre Law states that
such information will also be provided in the form of extracts and
copied documents from cadastral files. Additional regulations and
rules will define the procedures for filing the relevant applications to
obtain such information.
Classifications of real estate

Russian real estate is classified on the basis of its intended use (ie
either for residential or non-residential purposes). The specific use
should be identified in the lease, the certificate of ownership, or the act
of permanent use, as well as in the BTI. The use of buildings is also
governed by the decree or other document that was originally issued in
relation to that building. The property of a privatized enterprise may
also be subject to additional use restrictions imposed by its specific
privatization plan.
It should be noted that all real estate construction requires state
permits and consent.
Payments for real estate

At present, when a foreign investor purchases or simply leases real
estate from Russian residents, payments for the real estate purchased
and, usually, lease payments effected in foreign currency, are classified
as capital transfer transactions. Previously, every such capital transfer
transaction required a specific licence from the Central Bank of the
Russian Federation (the CBR). However, the licensing requirement for
foreign currency payments by foreign tenants to Russian landlords or
sellers has been recently abolished. Furthermore, under the new
Federal Law On Currency Regulation and Currency Control, the
greater part of which will come into effect on 17 June 2004, foreign
currency payments made by foreign investors to Russian residents in
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341
consideration for purchased or leased immovable property will no

longer be deemed capital transfer transactions. This development
certainly testifies to further liberalization of Russian currency control
legislation. Additionally, when both the seller and the buyer, or the
lessor and the lessee, are foreign legal entities, a payment in foreign
currency to an offshore bank account is also possible. Such transactions,
however, may have tax consequences, particularly with regard to withholding tax.
Residential real estate

By now, many apartments have been privatized and are in private
ownership. Federal Law No. 72-FZ of 15 June 1996, On Partnerships of
Home Owners (the Condominium Law), provides the basis for the
formation of condominiums, including those formed by a developer
prior to their construction, although such ventures are limited to
buildings that consist primarily of residential premises. Additional
regulations are also required, some of which have already been passed
in Moscow and St. Petersburg. Presently, simple condominiums are
also being registered.
Mortgage of real estate

Federal Law No. 102-FZ On Hypothec (Mortgage of Real Property) of
16 July 1998 came into effect on 22 July 1998 and was subsequently
amended on a number of occasions (the Mortgage Law). The Mortgage
Law significantly improves the importance of a mortgage as a
creditors instrument for securing its investment. It is important to
note that buildings and structures can be mortgaged only simultaneously with the land plots on which such buildings and structures are
located.
The concept of a mortgage under Russian law differs from that in
common law jurisdictions. In Russia, a mortgagee cannot automatically acquire rights to the mortgaged property if default occurs under
the secured obligation. In most cases the mortgaged property must be
sold at a public auction. The proceeds will then be used to repay the
debt. There are two types of foreclosure on mortgaged property: judicial
and extra-judicial. The parties may also enter into a contract for the
transfer of the mortgaged property to the mortgagee to set off the
secured obligation. However, such an agreement can be concluded only
after the default has occurred under the secured obligations.
In order to be valid, a mortgage agreement must be certified by a
Russian notary and registered with the relevant state real property registration authority. The local office of the state real property registration
342
authority and all of the land committees can provide information on the
absence or presence of a valid mortgage over immovable property.
According to the Mortgage Law, the following types of property can
be subject to a mortgage:
1. land plots (with those exceptions stated in the Mortgage Law);
2. enterprises registered as real estate;
3. buildings, structures, and other immovable property that are used
for business activities;
4. residential houses, apartments and parts thereof, consisting of one
or several isolated rooms;
5. cottages, garages, and other structures for personal use;
6. aircraft, sea and river vessels; and
7. a lessees interest in leased real estate, which may be the subject of a
leasehold mortgage.
The terms and conditions of a mortgage may restrict the owners or
users capability to dispose of the property, including its contribution to
charter capital and/or lease to third parties. Therefore, confirmation of
the absence or existence of a valid mortgage over the property is
important. If there is a valid mortgage, the purchase can be effected
only with the consent of the mortgagee. Even then, notwithstanding
such consent, the mortgage will follow the immovable property unless
and until the primary obligation secured by the mortgage is performed
and the property is released from it.
The Mortgage Law as amended includes some significant changes
that are important specifically for securing financing through mortgages. Thus, revised Article 78 of the Mortgage Law provides that foreclosure by the mortgagee on a mortgaged residential house or
apartment and disposal of such property constitutes grounds for termination of occupancy rights of a mortgagor and his family members
residing together in this residential house or apartment, provided that
this residential house or apartment was mortgaged under a mortgage
agreement to secure the return of a loan granted for the purchase or
construction of this residential house or apartment.
This means that now (unlike prior to the revision of the Mortgage
Law) a mortgagee can demand that a mortgagor vacate the mortgaged
property if the mortgagee intends to foreclose on it. However, this rule
would apply only if the mortgaged property was mortgaged to secure
the repayment of a loan taken by a mortgagor to purchase or construct
the property. It is also important that those individuals who occupy the
mortgaged property, pursuant to a lease or a naim agreement (under
Russian law, a specific type of residential lease where the lessee is a
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private individual), cannot be moved out upon foreclosure on the mortgaged property. Such a lease or a naim agreement concluded prior to
the mortgage agreement will remain in force and can be terminated
only in the specific circumstances provided for by the Russian Civil
Code or applicable housing legislation.
Some new changes were introduced in the Mortgage Law as
amended in respect to the extension of an existing mortgage on a
newly-constructed building. The previous version of Article 65 of the
Mortgage Law provided that a mortgage did not extend to buildings
and structures constructed on the mortgaged land plot unless
otherwise stipulated by the mortgage agreement. Based on this
provision of the Mortgage Law, real property registration authorities
demanded that an addendum to the existing mortgage be signed each
time the existing mortgage was to be extended to cover a newlyconstructed building or structure. This slowed the process down and
increased the cost, specifically a notary fee of 1.5 per cent of the mortgaged property value had to be paid each time such an addendum was
executed. Currently, according to Article 65 as amended, the existing
mortgage of a land plot automatically extends to cover a building or a
structure erected on this land plot by the mortgagor, unless otherwise
provided by the mortgage agreement. The revised Article 65 of the
Mortgage Law allows a mortgagee to extend the mortgage over a land
plot to all buildings and structures that may be constructed on the plot
without need for a subsequent addendum.
The amendments to the Mortgage Law introduced by Federal Law
No. 1-FZ of 5 February 2004 now permit the mortgage of any land plot,
including agricultural land, unless it has been withdrawn from or is
limited in circulation, or if it is held in state or municipal ownership.
5.9
Competition Law
Paul Melling, Partner and Sergei Voitishkin,
Partner, Baker & McKenzie CIS, Limited
The basic law regulating antimonopoly questions is the Russian

Federation Law on Competition and the Restriction of Monopolistic
Activity in the Commodity Markets (the Competition Law), enacted 22
March 1991, as amended. The Russian competition watchdog is the
Federal Anti-Monopoly Service (the FAS).
The Competition Law regulates four areas of particular interest to a
foreign investor:
1. abuse of a dominant position;
2. agreements limiting competition;
3. establishment of companies; and
4. mergers and acquisitions.
Abuse of a dominant position

Dominant entities are subject to certain restrictions on their activities.
Determining whether a particular entity enjoys a dominant position
involves a complex evaluation of various factors. The most important
factor is the entitys market share.
For entities with a market share of 65 per cent or greater, there is a
presumption of market dominance. If a market share is between 35
and 65 per cent, there is a rebuttable presumption of non-dominance.
However, the FAS may deem that such a non-dominant entity still
holds a dominant position based on the stability of the entitys market
share, the market share of its competitors, the barriers to market entry
and/or other factors. For entities with a market share of 35 per cent or
less, there is a conclusive presumption of non-dominance.
For those in a dominant position, the Competition Law prohibits any
of the following activities:
Competition Law
345
withdrawal of goods from circulation with the intent to create or

maintain a shortage of such goods;
creation of conditions that place one or more legal entities in an
unequal position as compared to other entities in their ability to
access the market for particular goods;
imposition on a contracting party of contractual terms that are
disadvantageous or do not relate to the subject matter of the
contract;
creation of barriers to market entry for other legal entities;
support of high or low prices (ie price fixing);
discontinuance of production of goods for which there is a consumer
demand if it is possible to produce them without a loss; or
unjustified refusal to consummate a contract with particular
customers if it is possible to produce or deliver the relevant goods to
such customers.
Any of the above activities may be allowed if the dominant entity can
prove that the positive effects of a particular activity outweigh its
negative consequences.
Agreements limiting competition

The Competition Law prohibits agreements, transactions, or other
business activities of business entities operating in the same or similar
commodities markets that lead or may lead to the following:
control or fixing of prices, discounts, bonus payments, or surcharges;
increase or reduction of prices, or the manipulation of prices at
auctions/tenders;
division of the market by reference to territories, or according to the
volume of sales/purchases, the range of marketable goods, or the
range of sellers or buyers;
restriction of access to the market or the removal from the market of
other entities that sell or purchase particular products; and
refusal to conclude agreements with particular sellers or buyers.
The Competition Law further prohibits other agreements between
business entities operating in the same or similar commodities
markets, including agreements between non-competing entities, which
will or may result in exclusion, limitation, and elimination of competition or derogation of interests of other business entities.
346
Finally, the Competition Law prohibits agreements or other

concerted actions between non-competing legal entities (such as
potential sellers and potential buyers) acting in a particular market if
such agreements or other actions result or may result in the exclusion,
restriction, or elimination of competition. This rule, however, only
applies to legal entities with a joint market share in a particular
commodity market exceeding 35 per cent.
In certain cases, the above-mentioned activities may be permitted if
the business entity can prove that the positive effects of the action,
including effects in the socio-economic sphere, outweigh its negative
consequences, or if the entity can prove that federal laws permit such
agreements or business activities.
Establishment of companies
The founders of a new company must notify the FAS within 45 days
following the companys registration if the aggregate asset value of the
founders exceeds 200,000 times the monthly minimum wage (in May
2004 this corresponded to approximately $690,000).
Mergers and acquisitions

Mergers
Entities involved in a consolidation or a merger must receive prior
approval from the FAS if the aggregate asset value of the entities exceeds
200,000 times the minimum monthly wage. The procedures for obtaining
such approval are similar to the procedures used for acquisitions.
Acquisition of an interest in a Russian company

Acquisition of shares/participatory shares in a Russian company
Entities involved in an acquisition must receive prior approval from
the FAS if:
1. the aggregate asset value of the acquiror, its group of persons, and/or
the target company exceeds 200,000 times the minimum monthly
wage; or
2. either the acquiror, any entity of the acquirors group, or the target
company is included in the FAS Register of Entities with a Market
Share Exceeding 35 per cent in the relevant market.
In determining the threshold for asset values, the FAS takes into
consideration not only the acquiror and the target company, but also all
persons (individuals or legal entities) in the acquirors group of
Competition Law
347
persons. The broad term group of persons includes all individuals or

legal entities related to the acquiror as a result of controlling share
ownership or through certain management contracts, familial relations, and/or other de facto control mechanisms.
It is common practice for a foreign investor to buy Russian
shares/participatory shares and to become such a shareholder/participant in a Russian company. However, there are some legal formalities
associated with the acquisition of a stake, non-compliance with which
may seriously damage the interests of an investor.
The two most popular forms of organization for Russian companies
are joint stock companies (JSCs) and limited liability companies
(LLC). JSCs issue shares, which, under Russian law, are classified as
securities. Therefore, Russian securities legislation provides additional
regulations on transactions involving securities:
1. Each share issue must be registered with the Federal Financial
Markets Service. A failure to register will forfeit the share purchase
transaction under Article 168 of the Civil Code;
2. Sold shares must be paid for in full by the shareholders. Otherwise,
the transaction will be deemed invalid and may be challenged by
any interested party; and
3. Most shares exist in non-documentary form as entries in a shareholders register, which is maintained by the JSC or by third party
registrars. The title to such non-documentary shares is transferred as a
legal matter only at the moment of entry in the shareholders register.
Accordingly, it is very important to receive an excerpt from the shareholders register, confirming the buyers title to the acquired shares.
Participatory shares in an LLC are not classified as securities and do
not need to be registered. However, an existing participatory share can
be transferred only after it has been fully paid for. In addition, a buyer
will obtain the participants rights in the LLC only after the LLC is
notified of the sale of the participatory share. Moreover, since all of the
participants in an LLC must be included in its charter and foundation
agreement, it is very important to make sure that the LLC participants
approve the relevant amendments to the LLC charter and foundation
agreement naming the investor as a new participant.
The advantages of a share (participatory share) purchase scheme
are that:
exposure of the purchaser to the liabilities of the target company is
limited to the nominal value of the purchased share (participatory
share); and
in most cases, the procedure for the share (participatory share)
purchase does not require any lengthy or onerous state registration
348
(with the exception of the LLC itself, as to which the charter and the
foundation agreement must be amended to reflect that the
purchaser has become a participant in the LLC).
Unfortunately, there are also some disadvantages to such a scheme:
due to LLC shareholders right of first refusal, the purchaser must
be approved by the existing shareholders in the company, which can
be difficult if the company has shareholders other than the seller;
potential problems may arise when returning to a foreign purchaser
its investment upon the liquidation of a company (especially a JSC);
and
the purchaser must complete certain corporate formalities prior to
the share sale.
The purchaser of shares should take the following steps:
1. perform due diligence on the target company;
2. obtain prior approval from the FAS as required by the Article 18 of
the Competition Law;
3. ensure that the appropriate corporate procedures are followed (such
as the waiver by other shareholders of their pre-emptive rights);
4. sign a share purchase agreement and any other required documents
(such as a share transfer instruction in the case of JSCs, or a notification to the company in the case of LLCs); and
5. ensure that the purchaser of the shares is entered into the shareholders register of the JSC or that a new version of the charter and
foundation agreement, reflecting the purchaser of a participatory
share as a participant in the LLC, is properly approved and registered.
Acquisition of the sssets of a Russian company
The main purpose in purchasing assets from a third company is to use
the acquired assets in ones own business.
Under Russian law, two main methods of purchasing assets are
available:
1. purchase of particular assets; and
2. purchase of an enterprise.
The advantages of purchasing particular assets are:
the procedure is simple and does not require state registrations
(except for specific objects, for example, in the case of the purchase of
real estate objects and intellectual property objects, such as patents
and trade marks); and
Competition Law
349
the purchaser does not acquire any of the liabilities of the seller,
unlike in the case of the purchase of an enterprise or shares.
An asset purchase also has some disadvantages:
encumbrances over pledged assets will be transferred along with the
assets;
there is possibly an obligation to pay VAT; and
acquisition of certain assets can require state registration (real
estate objects, some intellectual property objects, etc).
Purchase of an enterprise
An acquisition of an enterprise is advantageous because the purchaser
acquires a block of tangible and intangible assets, which allows it to
launch or maintain a business. The purchase of an enterprise is, in
reality, the acquisition of a business.
However, there are also disadvantages to enterprise acquisition:
the purchaser acquires not only the assets but also the liabilities of
the seller attributable to those assets;
applicable Russian legislation provides for the joint liability of the
purchaser and the seller of the enterprise to its creditors; and
if an enterprise owns any tangible property (eg a house, a car, a lake,
or a satellite dish), it is necessary to register the enterprise as a real
estate object and to register the purchase agreement with the body
of justice for State Registration of Real Property Rights and Real
Property Transactions.
A purchaser of assets and/or enterprise(s) must take the following
steps:
1. perform due diligence on the purchased assets (mainly, due diligence
as to the title and the legal status of the seller and the powers of its
officers);
2. obtain prior approval from the FAS as required by Article 18 of the
Competition Law;
3. ensure that the appropriate corporate procedures are followed (such
as the approval of a major transaction, the approval of an interested party transaction);
4. sign an asset/enterprise purchase agreement and the other required
documents; and
5. complete required state registrations (registrations of the rights to
and transactions with real estate objects, the registration of enter-
350
prise purchase agreements and/or the registration of assignments of

patents and trade marks, etc).
Procedures and timing

If the FAS determines that the establishment, merger, or acquisition
may restrict competition or strengthen a dominant position, it may
request additional information and documentation. The FAS may also
require the parties to take measures to ensure competition.
After all documents have been submitted, the FAS must issue a
written decision within 50 days. In practice, the investor can expect a
much longer time period to pass before the FAS decision is issued.
Appendices
Appendix 1
Learning from the

Russian Experience:
Regional Debt Defaults
and Recovery 19982003
Eugene Korovin and Elena Okorotchenko,
Standard and Poors Ratings Direct
Russian local and regional governments (LRGs) are once again

borrowing on the capital markets after a deep slump during 19982000
that followed numerous defaults. Over 2003, the Russian LRG bond
market more than doubled in size and now totals $3.3 billion (as of
mid-2004). Since 2001, there have been no publicly recorded defaults,
except for that of Primorskiy Krai, which defaulted on a small bond
issue in 2001.
As the bond market reaches new heights and new issuers enter the
market, investors have become ever more concerned about potential
defaults and adequate assessment of entities creditworthiness. This
appendix analyses common default triggers and recovery rates, and
compares the circumstances of the 19982000 default wave with the
present situation.
For the purposes of this study, a default is a non-payment of interest
or principal or coercive exchange in which the creditor has no real
alternative but to accept the offer, which is unfavourable.
Delay or non-payment to the federal government is not regarded as
a default for the purposes of this study. Borrowing from the federal
budget is a component of the Russian intergovernmental budgetary
system. Budget loans are repeatedly prolonged, written off, or used to
replace grants.
Publicly available data only represents the top of the default
iceberg. Poor disclosure of LRG defaults is common in Russia, as in
many other European countries. Lack of data on municipal defaults
makes it impossible to include them in this study.
354
Appendices
Numerous defaults after the crisis of 1998

Russian RGs direct debt started growing rapidly after the stabilization
of the national capital market in 1996. By 1998, direct regional debt
amounted to at least 25 per cent of consolidated regional budget
revenues, up from 15 per cent in 1997. The simultaneous increase in
debt service payments caused by a high proportion of short-term debt,
with an average duration of less than one year, combined with yawning
gaps in budget balances, increased exposure to debt refinancing risks.
An increase in interest rates significantly worsened borrowing
terms in the first half of 1998. Coupled with urgent social expenditures, this increase prompted several RGs to default in May/June.
On 17 August 1998, the federal government announced the devaluation of the rouble, the halt of federal government bond trading, and a
moratorium on corporate external debt payments. This prompted an
avalanche of regional defaults, driven on by the growth of debt service
payments on foreign currency debt, the collapse of the national capital
market, and RGs poorer liquidity.
During 19982001, at least 57 Russian RGs, out of a total of 89,
defaulted. Information on 123 overdue obligations, with a total amount
of 22 billion Russian roubles ($771 million in current prices), is publicly
available. By 2001, the number of defaults had fallen sharply (see
Figure A.1).
Foreign currency-denominated debt accounted for two-thirds of
total defaulted obligations. The largest defaults, representing more
than R2 billion each, were committed on foreign currency-denominated
obligations. For example, Nizhniy Novgorod Oblasts obligation was
eurobonds, and those of the republics of Tatarstan and Sakha, the
Defaulted amount
(left scale)
(Mil. $)
Number of defaults
(right scale)
90
600
80
500
70
60
400
50
300
40
30
200
20
100
10
0
0
1998
1999
2000
Figure A.1 Defaults by Russian regions
2001
2002
Appendix 1: Regional Debt Defaults and Recovery 19982003
355
Leningrad Oblast, and the Yamal-Nenets Autonomous Okrug (YNAO)

were syndicated loans.
Bonds and bank loans each account for about one-half of total
defaulted obligations. In practice, however, the proportion of bank
loans is inevitably higher because loan restructurings are often not
made public (see Figure A.2).
Bank loans
(2%)
Agrobonds
(17%)
Subfederal bonds
(17%)
Bank loans
(foreign currency)
(51%)
Eurobonds
(foreign currency)
(13%)
Figure A.2 Russian regions default by debt instrument
Default triggers
In general, RGs defaulted due to a lack of debt service capacity or a
general unwillingness to pay. In 19981999, several RGs including
Tatarstan, Nizhniy Novgorod, and YNAO defaulted because impending
debt service payments totalled 2629 per cent of their budget revenues.
In contrast, in 2000, the cities of Moscow and St. Petersburg met
their obligations in full and on time, even though their debt service was
at the critical level of 27 per cent of revenue for both cities. This divergence in behaviour highlights the importance of willingness to pay as a
factor for LRGs creditworthiness. In difficult financial situations, and
unlike corporates, which are subject to bankruptcy and liquidation
laws, prioritization of payments plays a crucial role.
Moscow, St. Petersburg, and some other regional governments
managed to meet their debt obligations owing to an efficient set of
emergency measures. Their initiatives included active debt
management, such as purchase on the secondary market, postponing
and cutting current expenditures, and suspending capital projects.
Common default triggers included:
poor liquidity non-cash payments, high seasonality of revenues,
and high arrears;
lack of financial flexibility inability to raise revenues or cut
expenditures;
356
Appendices
economic and financial crises;

high-risk debt profiles short-term debt, bullet maturities, and high
foreign exchange risk;
poor debt management; and
an unsupportive intergovernmental budgetary system.
The unwillingness of RGs to pay during this period was often caused by:
refusal to pay debt contracted by previous governments corruption
or inefficiency was often blamed;
the forced nature of debt obligations the obligatory conversion of
enterprises debt into regional debt by the Ministry of Finance, for
example;
inefficient enforcement procedures regions used loopholes in legislation that made it almost impossible for creditors to get their
money back through the courts; and
the default example set by the federal government.
Poor liquidity
RGs liquidity was constrained by the widespread practice of collecting
budget revenues in non-cash forms, such as mutual settlements,
commercial paper, the delivery of goods and services, and tax exemptions. This practice was very specific to Russian RGs. In 1997, non-cash
revenues accounted for half, on average, of regional budget revenues,
and up to 90 per cent in some regions.
The actual financial position of RGs accustomed to non-cash budget
execution was considerably poorer compared with that arising from
official financial statements in 19981999. Below-par actual value of noncash revenues and expenditures differed widely across RGs and prevents
any reliable adjustment of RGs financial figures for that period.
Cash reserves were consequently insufficient to support liquidity
when LRGs faced significant debt payments. Reserves totalled only 2.5
per cent of revenues in 1997.
Revenues are often highly seasonal. In some cases, only 15 per cent
of revenue is collected during the first quarter of the year and 40 per
cent during the last. Mounting arrears aggravated the problem.
Lack of financial flexibility

Rigid spending structures did not leave RGs much opportunity to cut
budget expenditure. Capital expenditure covered only pressing
investment needs, was already low, and was usually urgent. The
majority of current expenditure was obligatory wages and social
357
allowances earmarked, or delegated by federal government.

Deferrable expenditure had already been postponed by accumulating
accounts payable, which reached 21 per cent of total expenditure on
average in 1999, even on obligatory expenditures. Due to tight control
over tax rates, shares, and collection by the central government, LRGs
also had little room for manoeuvre in terms of revenues.
Economic recession and financial crisis

The recession of 1998 manifested in a 6.4 per cent drop in GDP
affected budget revenue collection. Several RGs barely managed to
collect 7080 per cent of their budgeted revenue. In addition, the
collection of a large part of revenues in non-cash forms meant that they
could not be used for salaries or debt repayment.
The collapse of the banking system, a typical event for countries in
default, undermined liquidity and complicated tax collection and debt
payments. Cash reserves deposited in insolvent banks were frozen. Tax
arrears rose because insolvent banks, having no funds, could not
execute taxpayers payment orders.
Risky debt profiles

RGs financial positions were further sapped by their exposure to high
foreign exchange and refinancing risks. Debt was largely short term,
only 200250 days on average in 1998, with bullet maturities. This was
the natural result of the shallow and speculative Russian capital
market. In 1997, borrowing for refinancing purposes exceeded net
borrowing and amounted to 9 per cent of consolidated regional budget
revenues. Sharp increases in interest rates, up to 100150 per cent in
the summer of 1998, prevented new borrowing by most LRGs. High
foreign-exchange risk manifested itself when the rouble value of
foreign currency denominated obligations tripled in summer 1998.
RGs with onerous foreign currency debt could not cope with the
increased debt burdens and had to default. The Republic of Sakhas
debt burden, for example, increased to 60 per cent of budget revenues
from 17 per cent.
Poor debt management

Excessive borrowing was the predictable result of RGs aggressive and
shortsighted financial policies and inefficient regulation by the federal
government.
Speculative use of borrowed funds and the channelling of borrowed
money to cover current expenditure deficits undermined debt service
capacity. Some RGs invested borrowed funds in risky securities, such
as federal government bonds, or deposited them in commercial banks.
358
Appendices
These investments were lost as a result of the federal governments

default and the collapse of the banking system.
Unsupportive intergovernmental budgetary system

General financial support from the federal government was irregular
and could not be relied upon. Even grants were distributed unevenly
within a financial year. Financial assistance in distress situations was
not forthcoming because the government had problems of its own. Such
a break of intergovernmental fiscal arrangements in a period of
sovereign distress is typical for developing countries and represents a
significant risk for RGs, especially those highly dependent on the intergovernmental budgetary system.
Unwillingness to repay debt contracted by preceding

administrations
Some RGs defaulted after changes in administration owing to regional
elections. Newly elected governors refused to repay debt contracted by
their predecessors, claiming that these obligations were contracted
illegally or used ineffectively and therefore should not be repaid.
The forced nature of debt obligations

RGs often refused to repay debt that they considered to be imposed on
them. This was the case with the agrobonds issued in 19971998 by 70
RGs. They were forced to convert the guarantees they issued to
support agricultural enterprises into direct obligations in the form of
bonds. Issued bonds were passed to the Ministry of Finance. The
ministry then placed the bonds among private creditors through
auctions. Many regions felt that this debt was not their true obligation.
Inefficient enforcement procedures

Inefficient and irregular enforcement procedures contributed to the
corruption of RGs credit culture. RGs missed debt payments,
supposing that creditors would not succeed in enforcing payment. The
Budget Code stipulates that the claims of creditors may only be
satisfied after all other planned budget expenditures. Even if creditors
obtained a court judgement in their favour, the authorities often failed
to enforce the payments.
In 2000, the Budget Code introduced an alternative legal procedure
for dealing with insolvent RGs. The federal government could now
impose external control over regional budgets. To date, however, the
federal government has not applied this regulation to any insolvent
RGs. Attempts by creditors to oblige the government to do so have
also failed.
359
Default by the federal government

Several RGs followed the example of the federal government and
defaulted on certain debt obligations in 19981999. These RGs claimed
to have a moral right to default because their debt service capacity was
affected by the impact on the federal government of the growth of
foreign currency debt service, the collapse of the banking system, and
the tax base recession. The federal governments examples of selective
default and protracted negotiations regarding the terms of debt
restructuring were often followed by RGs.
Restructuring and recovery

The restructuring of overdue debt was generally protracted and
coercive. Restructuring terms were usually unfavourable for creditors.
Enforcement procedures could not protect creditors rights, and so they
had no alternative but to accept the terms offered by the RGs. They
consequently incurred significant losses.
Duration of default: one to two years

Restructuring was usually protracted. No more than one-third of
overdue debt was restructured within the year of default (see Figure
A.3). About one-quarter has not yet been restructured.
The length of the restructuring period depended on the willingness
of the RG to pay, the creditors efforts to recover debt, and the type of
(Roubles, bln)
6
5
4
3
2
1
0
Not
Within five
restructured years of
(still in default) default
Within four Within three Within two

years of
years of
years of
default
default
default
Within one
year of
default
Figure A.3 Russian regions period of defaulted debt restructuring
360
Appendices
debt obligations. In general, external debt obligations, such as

eurobonds and bank loans, were restructured more quickly. The
restructuring of agrobonds, often overdue because of unwillingness to
pay, dragged on for years.
Coercive restructuring terms

Overdue debt was often repaid in non-cash assets, such as new bond
issues, stocks, property, and goods obtained through non-cash budget
revenue collection, with only a few exceptions, including bonds held by
individuals. Overdue debt could also be exchanged for tax exemptions
or accepted as tax payments or budget loan repayments.
Creditors exchanged overdue debt obligations for assets offered by
the RGs at auctions, usually for less than face value. Many creditors
incurred losses by attempting to convert debt obligations into cash as
soon as possible, because the market price of assets offered by RGs was
obviously significantly below par. There were also several cases of
forced debt swaps at below-par rates, including by Novosibirsk Oblast.
Low recovery rates on both domestic and external debt

Non-cash repayment schemes and the lack of data complicate the
assessment of recovery values. Lack or unreliability of data on the prices
of defaulted regional bonds is explained by the fact that the liquidity of
overdue issues was extremely low. Moreover, RGs often suspended
trading of overdue regional bonds on the stock exchange until restructuring was complete. Trading on Novosibirsks three bond issues, which
had a total value of R233 million, for example, was suspended for
54 months.
Generally, creditors incurred significant losses due to protracted
restructuring even if the overdue debt was repaid in full nominal
value.
Recovery rates on rouble-nominated bonds were quite low. Low
recoveries originated from a protracted restructuring process, the low
liquidity of defaulted bonds, unclear restructuring terms, and great
uncertainty about repayment of debt instruments received by
investors in exchange for defaulted bonds. Recovery on Omsk Oblasts
bonds, which defaulted in 19981999, for example, averaged 47 per
cent, varying from a mere 33 per cent up to a more significant 75 per
cent, owing to the non-simultaneous redemption of different issues.
This was completed by December 2003.
Recovery rates on bank loans were even more dispersed than for
bonds. The lower dispersion for bonds was a result of the general
uniformity of bond obligations and similarity of court procedures. Bank
loans, regulated by uniquely structured contracts, experienced more
differentiation and less predictable recovery.
361
Recovery rates on external obligations, such as eurobonds and syndicated loans held mainly by foreign creditors, were on a par with recovery
rates on rouble-denominated obligations. Creditors recovered 3848 per
cent on the Nizhniy Novgorod Oblast defaulted Eurobonds, for example.
Similar recovery rates on external debt could be explained by the
balance of RGs stronger willingness to pay on the one hand, but poorer
debt service capacity where RGs had substantial external debt on the
other. RGs concerns about their reputation among foreign investors
and better documentation of external debt deals strengthened RGs
willingness to pay. It resulted in shorter periods and better terms of
restructuring for creditors, including full repayment in cash and
accrual of interest on capitalized amounts of debt. Heavy debt burdens,
however, which had tripled after the drastic devaluation of the rouble,
exhausted their debt service capacity and demanded extension of
repayment schedules.
Continued default
Some RGs are still in default. Overdue debt obligations include
agrobond issues, bank loans, foreign currency guarantees (Kaliningrad
Oblast), and domestic bonds (Primorskiy Krai). In total, 17 RGs still
have overdue debt obligations.
It is evident that less favourable borrowing conditions are offered to
RGs with poor credit histories. Nizhniy Novgorod, therefore, did not
issue bonds in 2003 because potential underwriters offered placement
at yields of 30 per cent. Yields on bonds issued by the cities of Moscow
and St. Petersburg, the most creditworthy RGs, were 912 per cent.
The future
Debt expected to grow in the medium term
Raising funds from capital markets is becoming an ever more
important source of infrastructure investment for RGs because current
resources budget surpluses cannot meet growing regional
investment needs.
RGs debt burdens are expected to grow in the medium term, although
they remain low by international standards (see Figure A.4). During
20022003, regional direct debt as a percentage of operating revenues
increased by 5.5 percentage points compared with 2001. The central
governments initiatives to reduce regional borrowing from the federal
budget and delegate additional expenditure responsibilities, such as
raising the salaries of budget-sphere employees, will prompt RGs to
borrow from capital markets. Debt limits set in the Budget Code are
quite generous and should not limit debt growth in the medium term.
362
Appendices
Cash reserves movement
Other borrowing including bank loans
Budget loans
Subfederal (municipal) bonds
Regional budget balance
Balance/consolidated
budget revenues (%)
6
4
2
0
-2
-4
-6
-8
-10
1995 1996 1997
1998 1999 2000 2001
2002 2003
2004f 2005f
f = forecast
Figure A.4 Russian regional budgets deficit financing by instrument
Creditworthiness remains low despite some

improvements
The current financial and debt situation of Russian RGs is very
different from the pre-crisis, pre-default position of 19971998. In
2002, the stronger financial performance of rated RGs was indicated by
higher operating budget balances (a median of 21.7 per cent compared
with 13.5 per cent in 1998 and deficits of 1.3 per cent in 1997) and
manageable debt service (a median of 5.2 per cent of revenues
compared with 12.4 per cent in 1998). Budget revenues are collected
wholly in cash because non-cash settlements were prohibited in 2000.
Liquidity is supported by growing cash reserves (4 per cent in 2002
compared with 2.5 per cent in 1997) and better borrowing terms.
Although RGs creditworthiness has improved, credit risks remain
high, as the non-investment-grade credit ratings continue to indicate.
Major constraints on creditworthiness include low-quality financial
management, weak financial flexibility, and exposure to economic risks
and a volatile intergovernmental system. The RGs debt structure still
involves significant refinancing and currency risks.
363
Legal restrictions remain ineffective

As a partial answer to the numerous LRG defaults in 19981999, the
Russian federal government introduced the legal debt limits set in the
2000 Budget Code. These limits include requirements that:
total debt is less than budget revenues minus transfers from the
federal budget;
total budget revenues are greater than current expenditures;
budget deficits are less than 15 per cent of budget revenues minus
transfers from the federal budget (this regulation indirectly limits
net borrowing to 15 per cent of own revenues);
interest payments are less than 15 per cent of budget expenditures;
and
guarantees issued within one year are less than 5 per cent of budget
expenditures.
These limits are quite generous, however, and in Standard & Poors
opinion they fail to restrict borrowing to a level manageable by
emerging countries. In addition, poor discipline undermines the effectiveness of these restrictions. At the beginning of 2003, 41 RGs were in
breach of at least one of these restrictions.
Refinancing and currency risk exposure is lower but

remains important
The structure of regional debt has improved considerably compared
with its pre-1998 levels, but it still carries some currency and refinancing risks. Although the duration of debt liabilities has extended
significantly, the debt obligations of even the most creditworthy RGs
mature over two to three years a lower average than international
standards. Many RGs also remain exposed to foreign exchange risk
because foreign currency denominated debt amounted to 25 per cent of
total regional debt in 2002. Although the 2000 Budget Code prohibited
foreign currency denominated borrowing by RGs, they can still refinance foreign currency debt or incur debt fixed to an exchange rate.
Poor debt management quality still a concern, but

trends positive
Debt management remains inadequate in most Russian RGs. Only the
most progressive administrations are moving forward in terms of
management quality. The debt policies of the majority remain shortsighted and poorly institutionalized compared with their peers in
developed countries. Borrowed funds are spent ineffectively because
364
Appendices
borrowing plans are not incorporated into investment programmes.

Even though debt structures remain perilous, risks are not assessed
and most risk management techniques are ignored. The transparency
of debt operations remains low, due to poor disclosure and the
weakness of accounting.
RGs may suffer significant shortfalls in budget revenues due to high
exposure to large taxpayers or industries. Rainy day funds, conservative financial planning, and other hedging techniques are not
applied widely among the regions.
Intergovernmental budgetary system and local selfgovernment reforms lead to uncertainty

The ongoing intergovernmental budgetary system and local
government reforms undermine the stability of regional finances in the
short term. Irregular and sudden redistributions of tax revenues,
financial aid, and expenditure responsibilities inherently lower the
stability of regional finances and render any longer-term financial
policies practically impossible. Recent federal government initiatives,
including further equalization of per capita tax revenues and delegation of additional expenditure responsibilities, are expected to have
a negative effect on the wealthier rated RGs.
The vulnerability of RGs to possible sovereign distress remains
high. Their strong dependence on ever-changing intergovernmental
fiscal arrangements represents a considerable risk factor despite the
recent improvements in sovereign creditworthiness.
Weak enforcement mechanisms do not offer protection

to creditors
The default by Primorskiy Krai in 2001 clearly indicates that Russian
RGs cannot be compelled to pay. In the meantime, creditors continue
their unsuccessful attempts to recover debts, some more than five
years old, such as the agrobonds issued by Saratov Oblast. Expected
recovery rates remain low, owing to poor enforcement, which results in
higher borrowing costs for all RGs. Until creditor rights are protected,
long-term loans will be beyond the reach of most RGs.
In 20072008, the federal government plans to introduce a mechanism to enforce insolvent RGs to pay their debts Temporary
Financial Administration (TFA). TFA will be established in RGs with
overdue obligations exceeding 30 per cent of budget revenues. The TFA
is expected to prepare a debt repayment plan and oversee its implementation. TFA does not, however, guarantee the protection of the
creditors rights because only the federal government can establish it.
It cannot be introduced if overdue debt does not exceed 30 per cent of
revenues. Furthermore, the mechanism seems quite opaque.
365
Bailouts remain ad hoc

Recent bailout practices are likely to cause debt discipline problems if
repeated. The federal government helped Nizhniy Novgorod, for
example, to repay its first tranche of the restructured eurobonds. Ad
hoc bailouts do not contribute to the supportiveness and predictability
of the intergovernmental budgetary system but rather worsen entities
unwillingness to pay. RGs may expect similar bailouts when in
financial distress or when considering a default. This may encourage
unsound financial policies and more reckless borrowing.
Will there be more mass defaults?

Low credit ratings in general suggest that single defaults are likely.
Only one regional default occurred during 20012003, however.
Regional borrowing on the capital markets is now concentrated among
the most creditworthy regional governments (RGs). On the other hand,
less creditworthy RGs are now entering the market, and defaults are
more likely to occur because these new borrowers are more exposed to
the risks that were common default triggers in 19982000.
Most credit risk factors, including an unstable intergovernmental
budgetary system, tax base concentration, and dependence on a
shallow national capital market, are ubiquitous among Russian RGs.
On the other hand, improved liquidity, due to the elimination of noncash payments and longer debt maturities, is a significant
improvement on the late 1990s. Willingness to pay will continue to play
a crucial role in the determination of RGs probability of default.
Improvements in financial management quality give Standard &
Poors Ratings Services some hope that mass defaults will not be
repeated and that more attention will be paid to the credit quality of
individual entities in the sector. Improved enforcement mechanisms
and credit discipline such as clear mechanisms or the complete
absence of ad hoc bailouts by the federal government will be key to the
provision of creditor protection and reduced borrowing costs for RGs.
Copyright 19942004 Standard & Poors, a division of The McGraw-Hill
Companies. All Rights Reserved.
Appendix 2
Placing Investment
Projects within the
Context of National
Significance
Vitaly Mozharowski, Partner and Maxim
Popov, Senior Attorney, Pepeliaev, Goltsblat
& Partners
For investment projects time is crucial. So each day spent trying to

have the documents approved and re-approved by the authorities
matters. An additional impetus can be given to an investment project if
it is made nationally significant. This will also help to speed up and
very often to facilitate the execution of the necessary documentation.
Practically any investment project for the construction of manufacturing facilities starts from searching for and purchasing a land plot
where these facilities will be located. If a facility is made nationally
significant, within the meaning given to this term by art. 49.1 (2) of the
Russian Land Code, it will simplify the withdrawal of the land plot
chosen for locating this facility. The literal interpretation of art. 49 of
the Russian Land Code identifies two conditions which, if met simultaneously, make it possible to withdraw the land plot for national needs:
1. The facility proposed to be located on the land plot is nationally
significant.
2. There are no other options for locating this facility.
National significance of the facility

The Russian Land Code does not have a clear list of nationally significant facilities. Neither does it contain any criteria that would set these
Appendix 2: Investment Projects
367
facilities apart from facilities having any other significance (municipal,

private, etc). Nationally significant facilities should be understood to
mean federally significant facilities and facilities significant at the
level of a constituent entity of the Russian Federation. So the real
meaning of art. 49 of the Russian Land Code can be revealed through a
system analysis of other regulatory acts.
Quite illustrative in this context are the Rules for issuing permits
for the construction of federally significant real estate items and real
estate items in the territories of federally significant specially regulated town-planning entities (Resolution of the Russian Government
No. 221 of 10 March 2000). One of the grounds for issuing special
permits for the construction of real estate items in the territories of
federally significant specially regulated town-planning entities is the
decision of the executive authority of a particular constituent entity of
the Russian Federation with respect to the construction of a real estate
item which is significant at the level of this constituent entity and
preparation of documents required for obtaining a special permit for its
construction (clause 25).
The meaning and contents of the above-mentioned Rules definitely
suggest that, in any case, the basis for recognizing a facility as being
nationally significant is the decision of the competent governmental
authority adopted as appropriate.
Indeed, under the Russian Constitution the people exercise their
power directly and through the governmental authorities and local
governments. In other words, the decision of the governmental
authority to recognize a facility as being nationally significant actually
constitutes unconditional acknowledgement of public interests and
needs in respect of the land plot proposed for withdrawal. Public
interests and needs can justify legal restrictions on the rights and
freedoms of individuals (particular land owners, land users, land
holders and tenants) but only if such restrictions are commensurate
with the socially necessary result.
The provisions of federal legislation concerning the withdrawal of
land plots for national and municipal needs can and must be made
more specific in the laws of the constituent entities of the Russian
Federation for two basic reasons:
1. Under the Russian Constitution land legislation falls within the
joint competence of the Russian Federation and its constituent
entities (issues falling with their joint competence are regulated by
federal laws and the laws and other regulatory acts of the
constituent entities of the Russian Federation passed in accordance
with federal laws);
2. Withdrawal, including though buy-out, of lands for the needs of a
constituent entity of the Russian Federation is handled by the
368
Appendices
constituent entities of the Russian Federation (art. 10 of the Russian

Land Code).
The legislation of the constituent entities of the Russian Federation in
this area first of all defines:
the governmental authorities empowered to pass decisions recognizing facilities as being nationally significant;
criteria that make it possible to recognisze a facility as being
nationally (regionally) significant.
For instance, in the Moscow Region issues related to the construction of
real estate items that have regional or inter-district significance are
dealt with by the Moscow Region Government. The drafts of Moscow
Region regulatory acts concerning the location and development of
industrial facilities of federal, regional or inter-district facilities are
prepared and submitted to the Moscow Region Government for consideration by the Economy Ministry of the Moscow Region.
In some of Russias regions, for example in the Voronezh Region, the
standing co-ordinating executive authority responsible for governmental regulation of the development and location of manufacturing
facilities is the relevant Inter-departmental Commission for locating
manufacturing facilities in the territory of the region. It is the responsibility of this Commission to give prior consent for the location and
construction of manufacturing facilities.
Very often Commission Regulations provide that with respect to
regionally significant facilities, governmental regulation of the development and location of manufacturing facilities in the region is
effected and prior consent for the location and construction of manufacturing facilities is given by the Regional Administration as agreed
with the relevant district and municipal administrations.
With regard to regionally significant facilities, if the Commissions
opinion is positive, the decision that serves for the project owner as a
basis for starting work on a statement substantiating investments into
the construction is made by the Regional Administration.
Quite often an additional lever of influence over the Inter-departmental Commission is a positive opinion from the Expert Council for
the Strategy of Social and Economic Development of the Region under
the Head of the Regional Administration. Almost each Russian region
has bodies vested with similar functions.
In addition, there are formal criteria set out in regional legislative
acts that make it possible to recognize a facility as being nationally
(regionally) significant. One example is Voronezh Region Law No. 27OZ of 15 May 2002 On Governmental (Regional) Support for
Investment Activities in the Territory of the Voronezh Region. Under
this law, if an investment project appears on the Register of investment
Appendix 2: Investment Projects
369
projects of the Voronezh Region (the list includes projects selected

through competition), it means that this project is in line with the
priority avenues for the economic development of the Voronezh Region
and has economic and/or social significance for the region.
An additional argument in favour of recognizing a facility as being
nationally significant is inclusion of the investment project into the
Programme for the Economic and Social Development of the Region,
which exists in every constituent entity of the Russian Federation and
is subject to the approval of the regional legislature.
Absence of other options for locating this facility

The second condition for the withdrawal of the land plot for national
needs is the absence of other options for locating nationally significant
facilities. It is primarily aimed at protecting individuals and legal
entities from groundless termination of their rights to the land plots
they hold.
In the course of selecting a land plot for construction purposes
pursuant to art. 31 of the Russian Land Code, the local government is
obliged to make sure that there is only one option for locating the
facility that meets all requirements listed by the applicant (landscape,
geological structure of the land plot, access to resources, accessibility
and well-developed condition of the infrastructure, etc). This option
should also envisage locating the facility not on reserve lands but
within the boundaries of a land plot held by an individual or a legal
entity on the basis of a particular right.
The absence of other options for locating this facility should be
confirmed by a formal decision of the local government. It is quite
obvious that the applicant will stand a better chance of success if the
application for land plot selection and prior consent for the location of
the facility, as provided in clause 1 art. 31 of the Russian Land Code,
lists the strictest possible requirements in respect of the land plot,
including:
the area of the land plot (with due regard for the need to set up a
buffer zone, as the case may be);
landscape;
geological parameters of the land plot;
specifications for connecting to service lines (power supply, water
supply, sewerage, purification works, communications);
access to transport and social infrastructure facilities;
availability of qualified labour resources, etc.
370
Appendices
By ensuring that these conditions are met and by having the facility to
be constructed under the investment project recognized as being
nationally significant, the investor will essentially simplify the procedures of land withdrawal and facilitate further implementation of the
project in general.
Appendix 3
Useful Business-Related
Websites
www.gksoft.com/govt/en/ru.html
A directory of all of the federal government institutions of the
Russian Federation, including a list of all ministries.
www.embassyworld.com/embassy/russia1.htm
A directory of all of the Russian embassies and consulates around
the world.
www.embassiesabroad.com/embassy.cfm?embassy=home&fkcountry=75
A directory of foreign embassies and their websites in Russia.
www.users.globalnet.co.uk/chegeo/or www.russiaexport.net
Interesting English language site providing information about Russias
foreign trade since 1994, detailing different products imported and
exported to and from the Russian Federation, main trading partners,
and companies involved in foreign trade with Russia, etc.
www.rmg.ru
English language site containing information about breaking news
from the Russian financial markets, including market analysis, daily
quotes and indices, corporate finance, etc.
www.fipc.ru
The website of the Russian Governments foreign investment
promotion centre under the Ministry of Economy.
www.mid.ru
The Russian Ministry of Foreign Affairs English language site
providing current political information and various documents.
www.rbcc.com/
Russo-British Chamber of Commerce in the United Kingdom.
www.amcham.ru/
American Chamber of Commerce in Russia (Moscow based).
www.russianbusinesssite.com
The website of the Russian government entity set up to promote the
development of the small- to medium-size business sector in Russia.
372
Appendices
www.britemb.msk.ru
Website of the British Embassy in Moscow, listing the services the
embassy provides for British companies.
www.tradepartners.gov.uk
Advice and information from the UK government network that helps
UK companies trade internationally, including basic information
about Russias business environment and economy.
www.tradeuk.com
Trade partners UKs Internet service for international buyers and
UK exporters.
www.russianembassy.org
The website of the Russian embassy in Washington, DC a useful
resource providing excellent information on contemporary society as
well as recent and ancient history, plus links to news sources, etc
www.bisnis.doc.gov/bisnis/country/rusfed.cfm
US Department of Commerce site, established to provide Business
Information Service for the Newly Independent States (BISNIS) a
massive web-based resource pertaining to all aspects of business in
Russia. This includes a commercial overview of Russia, comprising
an economic profile, a foreign trade profile, a foreign investment
summary (giving information on intellectual rights and existing USRussia bilateral agreements), a banking and finance summary, a
section on practical information for travellers, and a section on
useful contacts/addresses.
www.eia.doe.gov/emeu/cabs/russia.html
US-DOE Energy Information Administration: Country Analysis Brief
on Russia a description of Russias energy economy, including oil,
natural gas and electricity. Elsewhere on this site are: a somewhat
dated (2000), but still useful, Country Energy Balance (www.eia.doe.
gov/emeu/world/country/cntry_RS.html) for Russia with
information on oil, coal, natural gas, and electricity; a Russian Oil
and Gas Exports Fact Sheet (http://www.eia.doe.gov/emeu/cabs/
russexp.html); and an Environmental Issues Briefing (www.eia.doe.
gov/emeu/cabs/russenv.html) with information on air pollution,
energy intensities, carbon emissions, renewable energy, and an
outlook for the 21st century.
www.odci.gov/cia/publications/factbook/geos/rs.html
CIA World Factbook 2003 a very useful information summary about
Russia, including sections on geography, people, government, economy,
communications, transportation, military forces and transnational
issues.
Appendix 3: Useful Business-Related Websites
373
www.russialink.org.uk/embassy
Online Russian international visa service. This is a non-government
site affiliated to the Russian Embassy in London, offering a full
range of visa support services for visitors to Russia (including
arranging invitations for business and tourist visas).
www.visatorussia.com/
Russian visa support services available online.
www.russiangateway.co.uk
Another of the Internet-based visa and travel support service
agencies serving the Russian Federation, providing information on
visas, tours and hotels from the UKs leading Russia experts.
http:// www.russia-travel.com
Official website of the Russian national tourist office.
www.city.ru
Russian cities on the Web a complete Internet-based guide to
numerous large (as well as not so large) Russian cities.
Appendix 4
Contributor Contact
Details
Allan & Overy
One New Change
London EC4M 9QQ, UK
Contact: Eric Zuy
Tel: +7(095) 725 7900
Fax: +7(095) 725 7949
Email: Eric.Zuy@AllenOvery.com
American Chamber of Commerce in Russia
79 Dolgorukovskaya Street, 14th floor
Moscow 103006, Russia
Contact: Alexander Kravtsov
Communications Director
Tel: +7 (095) 961 2141
Fax: +7 (095) 961 2142
Email: AKravtsov@AmCham.RU
Website: www.amcham.ru
Antanta Capital
8a Strastnoi Boulevard,
Email: info@antcm.ru
u
Contact: Denis Matafonov
Research Department
Tel: +7 (095) 783 9626
Fax: +7 (095) 783 9627
Trading Department
Tel: +7 (095) 783 4444
Fax: +7 (095) 783 9627
Baker & McKenzie CIS, Limited

Moscow Office
Sadovaya Plaza 11th Floor
7 Dolgorukovskaya Street
Tel: + 7 (095) 787 2700
Fax: +7 (095) 787 2801
Email: moscow.office@bakernet.com
Contact: Paul Melling
Email: paul.melling@bakernet.com
St. Petersburg Office
57 Bolshaya Morskaya Street
St. Petersburg 190000, Russia
Tel: + 7 (812) 303 9000
Fax: + 7 (812) 325 6013
Email: stp.office@bakernet.com
Contact: Maxim Kalinin
Email: maxim.kalinin@bakernet.com
Branan
10 Vostochnaya ul
Contact: John Marrow, Director
Email: jem@branan.ru
Additional contact:
Tatyana Baeva
Email: tab@branan.ru
CMS Cameron McKenna
Pavaletskaya Square 2/3
Contact: David Griston
Tel: +7 (501) 258 5000 (office)
Tel: + 7 095 108 7106 (mobile)
Email: David.Griston@cmck.com
Deloitte & Touche CIS
16/2 Tverskaya Street
Contact: Michael Bolan, Director of Marketing & Administration
Tel: +7 (095) 787 0600 x.2421 (direct)
Tel: +7 (095) 787 0600 (main)
Fax: +7 (095) 787 0601
Email: mbolan@deloitte.ru
375
376
Appendices
William Flemming
Tel: +7 (095) 937 3399
Fax: +7 (095) 937 3393
Email: flemming@imedia.ru
Firestone Duncan
Staropimenovskiy Pereulok 13, Stroyeniye 2, 6th Floor
Tel: +7 (095) 258 3500
Fax: +7 (095) 258 3501
Website: www.firestone-duncan.com
Contact: Jamison R Firestone
Email: jamison@fda.ru
OTAC Limited
47 Falcon Drive
Hartford
Huntingdon
Cambridgeshire PE29 1LP, UK
Tel: +44 (0) 7971 588437
Email: otac@ntlworld.com
Contact: Sergey Maslichenko
Email: Maslichenko@yahoo.co.uk
Krasnopresnenskaya nab. 12, Entrance 7
15th floor, World Trade Center-II
Tel: +7 (095) 967 00 07
Fax: +7 (095) 967 00 08
Email: info@pgplaw.ru
St. Petersburg Office
25 Nevskiy Prospect, Atrium
St. Petersburg 101000, Russia
Tel: +7 (812) 346 7708
Fax: +7 (812) 346 7709
Email: spb@pgplaw.ru
Website: www.pgplaw.ru
Kosmodamianskaya Nab.52, Bld.5
Tel: +7 (095) 967 6000
Fax: +7 (095) 967 6001
Website: www.pwc.com/ru
Contacts:
Keith Rowden
Leader, Energy Industry Services
Email: keith.rowden@us.pwc.com
Igor Lotakov
Senior Manager, PricewaterhouseCoopers
Email: igor.lotakov@ru.pwc.com
Alexander Chmel
Partner, PricewaterhouseCoopers
Email: alexander.chmel@ru.pwc.com
Vyacheslav Solomin
Senior Manager, PricewaterhouseCoopers
Email: vyacheslav.solomin@ru.pwc.com
Natalia Milchakova
Partner, PricewaterhouseCoopers
Email: natalia.milchakova@ru.pwc.com
Alexander Dragunov
Director, Customs Practice, PricewaterhouseCoopers
Email: alexander.dragunov@ru.pwc.com
Gennady Odarich
Lawyer, PricewaterhouseCoopers CIS Law Offices BV
Email: gennady.odarich@ru.pwc.com
Raiffeisen Bank Austria
17/1 Troitskaya Street
Contact: Elena Romanova
Head of Research
Tel: +7 (095) 721 9934
Fax: +7 (095) 721 9900
Email: eromanova@raiffeisen.ru
377
378
Appendices
RosBusinessConsulting
78 Profsoyuznaya Street
Tel: +7 (095) 363 1111 (switchbox)
Fax: +7 (095) 363 1125
Email: http://research.rbc.ru/
Websites: www.rbc.ru
Contact: Vyatcheslav Masenkov
Email: masenkov@rbc.ru
RMBC (Remedium group of companies)
Bakuninskaya 71
Tel: +7 (095) 780 3425
Fax: +7 (095) 780 3426
Contacts: Sirma Gotovats, Anton Timergaliev
Emails: evargashkina@rmbc.ru, antony@rmbc.ru
Website: www.rmbc.ru
Standard & Poors Ratings Direct
11 Gogolevsky Blvd, 9th floor
Contacts:
Ekaterina Novikova
Email: Ekaterina_Novikova@standardandpoors.com
Elena Anankina
Tel: +7 (095) 783 4130
Email: elena_anankina@standardandpoors.com
Robert E Richards
Tel: +7 (095) 783 4011
Email: rob_richards@standardandpoors.com
Index
References in italic indicate figures or tables.
accident insurance 262

accountants 330
Accounting Law 267
accounting standards 27274, 330
accreditation of representative offices
22526, 237
advertising, brewing industry 206
advertising tax 256, 260
Agency for Restructuring of Credit
Organizations (ARCO) 87
agricultural land 286, 28992, 334
AKM-com index 154
Alfa Bank 47, 80
alternative telecom operators 15051
AmCham 39, 4041
American investment 38
Anglo-American corporate governance
model 99
Anti-Monopoly Law 23536
Anti-Monopoly Ministry 166,
22930, 235
appellate jurisdiction 307, 308
arbitration 310
Arbitration Court 8485
arbitration managers 85
arbitrazhniy (commercial) court
system 32, 33, 304, 30506, 306,
30708
procedure 30810
ARCO see Agency for Restructuring of
Credit Organizations
Asian corporate governance model
100
assets acquisition 34849
Auchan 200, 203
auditing 26572
current developments 26871
history 26566
legislation 26667
rules 26971
Auditing Activity Board 268
August 1998 Crisis 70
automotive industry 17479
big three 17677
major FDI projects 17778
Avtotor 178
AvtoVAZ (Volgski Automobile Plant)
175, 176, 177
Baltika 208, 209
bank accounts
non-resident companies 96, 238
representative offices 218
resident companies 23839
banking sector 2328, 6978, 78
credits, assets and investments 24
current status 7172
deposits 24, 25, 26
effect on risk ratings 6566, 65
history 70
legislation 7273
lending 24, 27, 28, 7374, 8081
mortgage financing 76
reform plans 7677
regulation 6970
retail 2528, 7476, 7981
structural reform 4748
bankruptcy see insolvency regime
Banks Insolvency Law 87, 88
Bashkortostan, government economic
involvement 62
bilateral investment treaties 37
black market, pharmaceuticals
sector 19495
BMW 178
boards of directors 232
380
Index
bonds 94
yields on 2023
Bosco di Chiliegi 20304
branches of foreign legal entities
236, 32223
taxation 253
branding, brewing industry 21012,
210, 211, 212
brewing industry 20514
cities 207
competition 20910, 209, 210
demographics and market
characteristics 20607
distribution channels 21314, 213
national brand 21112, 211, 212
quality 21213
regions 20708
bribery xxix, 51
BTI see Bureau of Technical
Inventory
buildings
ownership 33637
regulations 28687
Bureau of Technical Inventory (BTI)
337
bureaucracy, effects on credit quality
5859
business addresses, legal
requirements 328
business culture xxviiixxxi
Business Ethics Commission 40
business structures/entities 21724,
23140, 31718, 326
bank accounts 96, 218, 23839
foreign employees 23940
limited liability companies
21921, 23334
open and closed joint stock
companies 22124, 23233
differences between ZAO and
OOO 23436
registration 22530, 23638
representative offices 21719, 236
cadastral registration of land 339
capital currency control 35, 9697
capital inflows, exchange rate effect
1720
capital outflows, trend towards 46

capital transfer transactions 340
cash-and-carry format 203
CBR see Central Bank of Russia
CDR-FOREM 129
CDU-System Operator 129
CED see Commercial Energy
Dialogue
cellular communications 158, 158
Central Bank of Russia (CBR) 47,
6970, 75, 77
exchange rate options 1315
Central Certification Licensing
Auditing Commissions 266
centralized political system, problems
with 6163
Chief Accountants 330
Circulation Law 334, 335
Civil Code 34, 217, 219, 221, 231,
232
currency 95
property 283, 287, 338
securities 92, 94
civil law system 3336
closed joint stock companies 22124,
233
clothes market, luxury 20304
coal consumption and production
14041, 14243, 144
Code of Audit Ethics 271
Code of Corporate Conduct 223
commercial court system see
arbitrazhniy court system
Commercial Energy Dialogue (CED)
40
communications equipment
manufacture 16263
communications facilities market
15662, 157, 158, 160, 161
companies see joint stock companies;
Competition Law 344
competition law 34450
abuse of a dominant position
34445
agreements limiting competition
34546
mergers and acquisitions 34650
Index
Concept for Automotive Industry
Development 174
Conception for Developing the
Russian Telecommunications
Equipment Market 163
Condominium Law 341
Constitution 4, 3031, 334
Constitutional Court 32, 33
constitutional structure 3032
construction stage, investment
projects 320
consumer-services sector growth
4344, 44
contractors, as alternative to
employees 331
contracts of employment 31112
termination 31314
contributor contact details 37478
copyright 29799
Internet 302
troubleshooting 29899
corporate credit ratings 5658, 57
corporate governance 5152, 53,
99106
effect on country risk ratings
5961
oil and gas industries 12122
Corporate Governance Code 104
corporate Intranet equipment
161
corporate law, investment projects
32223
corporate securities 92
Corporate Wealth Maximization
Model (CWM) 99100
corporations, largest xxv
corruption xxix, 51
court systems 3233, 30410, 305,
306
procedures 30810
courts of common jurisdiction
30405, 305, 30607
procedures 30810
credit assessment difficulties 80
credit bureaux, plans for 47
credit ratings, corporate xxvi, 55,
5658, 53
Criminal Code 299
381
currency legislation 35, 7273,

9598
movement of capital 9698
penalties 98
resident status 96
salary payments 313
Currency Law 95, 9798, 34041
custom programming of IT market
169, 170, 171
Customs Code 36, 249, 27579
customs legislation 36, 249, 27580,
32324
CWM see Corporate Wealth
Maximization Model
cyber-squatting 302
data protection, employee data 314
debt defaults and recovery, regional
35365
default triggers 35559
future 36165, 362
1998 crisis 35455, 354, 355
restructuring and recovery
35961, 359
Decree for the Support of Insolvent
State Enterprises 8283
Decree on the Temporary Regulations
on Auditing Activities 266
Department for the Organization of
Auditing Activity 268
Department for Visas and
Registrations (UVIR) 316
deposit insurance system 75, 80
Development of Telecommunications
programme 163
digital communications channels 157
directors, limited liability companies
234
disclosure, and transparency levels
6364
discount outlets 202
disposable income growth 45
dispute resolution processes 32, 33,
4041, 30410
alternative procedures 310
courts 30408, 305, 306
procedure 30810
property 28788
382
Index
dividend income, tax on 258

DIY stores 20203
documentation
design development 320
pre-investment project 31920
domain names 30203
double taxation treaties 37, 26364
Duma see State Duma
EBRD see European Bank of
Reconstruction and Development
e-commerce 30103
economic context xxivxxv, 1129,
29, 38
concentration issues 63
investment climate 4246, 44, 45
retail industry 199200
see also monetary issues
Efes 208
Eldorado 202
electricity industry 12835
consumption 140, 141
investment opportunities 13435
stakeholders 134
structural reform 48, 13134, 131,
133
supply 144
electronic signatures 303
electronics stores 202
employment contracts 31112
employment law 23940, 31116,
33031
contracts 31112
hours and holidays 312
minimum wage and currency
control 31213
personal accreditation 315
termination of employment
agreements 31314
work permits 31415
Energos 130, 132
energy industry 13645, 144
balance forecast 139
efficiency constraints 13739, 138
GDP growth 13637, 138, 138
investment constraints 14445,
144
structural reform 48
supply 14244, 142
see also electricity industry; gas
industry; oil industry
entrepreneurial start-ups 32632
operational issues 32932
setting up a venture 32629
environmental regulation, oil and gas
industries 121
Europe, convergence with 50
European Bank of Reconstruction and
Development (EBRD) 46
European corporate governance
model 9910
exchange rates 11, 1215, 12, 13
implications for economy 1720,
18, 19
excise tax 34, 248
executive body of companies 232
executive branch of government 31
exports 11
energy infrastructure problems
11112, 112, 118
implications of appreciating
exchange rate 17
Exxon Mobil Corp 62
fabricated pharmaceutical products
19495
farm land 286, 28992
FAS see Federal Anti-Monopoly Service
FDI see foreign direct investment
Federal Agency for Government
Communication 166
Federal Anti-Monopoly Service (FAS)
93, 344, 346, 350
Federal Assembly 3132
Federal Commission for the
Securities Market (FSC/FCSM)
91, 93, 94, 22930
Corporate Governance Code 104
Federal Financial Markets Service
(FFMS) 69
Federal Grid Company (FGC) 129,
132
Federal Security Service 33
Federal Service for the Financial
Markets (FSFM) 91, 93
Index
federal structure 31
federal taxes 250
Federation Council 7, 89, 32
FFMS see Federal Financial Markets
Service
FGC see Federal Grid Company
financial reserves 4546
first instance jurisdiction 30607,
30708
First Law on insolvency 83
Fitch ratings 45
fixed communications facilities
15859
fixed-term contracts 31112
Ford Motor Company 178
foreign direct investment (FDI)
xxxi, 19, 43
automobile industry 17778
taxation 24647
foreign investment 19
latest developments 3841
legislation 3637
restrictions 37
retail sector 200
see also foreign direct investment
Foreign Investment Law 236,
32425
foreign legal entities, taxation 253
FOREM 129, 132
forest land 292
Fradkov, Mikhail 6
free trade arrangements 4950
FSC/FCSM see Federal Commission
for the Securities Market
FSFM see Federal Service for the
Financial Markets
gas industry 114, 116
dependence on 63
key investment issues 11722
regulatory and legal environment
12327
structural reform 48, 49
supply 144
GAZ see Gorky Automobile Plant
Gazcom 161
383
Gazprom 114, 116, 119, 126

credit rating 6263
GDP growth 38, 43, 44
energy industry 13637, 138, 138
implications of exchange rate
appreciation 18
general jurisdiction, courts of 33
General Motors 17778
geography xx, xxi, xxii
German corporate governance model
99100
Globalstar 161
Golden Telecom 151
goods sector growth 43, 44
Gorky Automobile Plant (GAZ) 175,
176
government 57, 3839
growth of the economy, exchange rate
effect 17
Guta Bank 47, 75
High Arbitrazhniy Court 32, 33
holidays 312
hospital pharmaceutical purchases
187, 189
hours of work 312
household department 5
hypermarkets 203
ICLG see Institute of Corporate Law
and Corporate Governance
IFC see International Finance
Corporation
IFRS see International Accounting
Standards
IKEA 200
Illarionov, Andrei 5
immovable property rights
registration 33940
import and installation contracts 320
imports
implications of appreciating
exchange rate 17
pharmaceuticals 18384, 184,
191, 192
income tax, personal 34, 24547,
25657
384
Index
inflation 1517, 16, 44

Insolvency Law 8890
insolvency regime 8290, 86
current status 8890
history 8288
Institute of Corporate Law and
Corporate Governance (ICLG) 52
institutional telecom operators 150
intellectual property 294301
copyright and neighbouring rights
29799
e-commerce 30103
patents 299301
trade marks 29497
interest rates 11, 2023, 20, 21, 22
arbitrage 17
interest units, limited liability
companies 220
International Accounting Standards
(IFRS) 272, 273
International Finance Corporation
(IFC) 46
international law 36
Internet 159
e-commerce 30103
trading on 17071
Intranet equipment 161
investment
current climate 4254
corporate governance 5152, 53
economy 4246, 44, 45
law 51
politics 4950
structural reforms 4749
energy industry 14445, 145
pharmaceutical industry 19697
see also foreign direct investment
investment banking 74
investment projects 31725
corporate law 32223
customs payments 323
foreign investment law 32425
land relations 321
nationally significant 36670
stages 31721
tax 323
IT market 16873, 168, 169, 170, 171
largest participants 172
Japanese corporate governance model

100
joint stock companies (OAO and ZAO)
22124, 23233
contributions to capital 229
formation of charter capital
229
compared 23436
share acquisition 34748
Joint Stock Companies (JSC) Law
91, 94, 221, 223, 231, 232
auditing 267
judicial system 3233
Kasyanov, Mikhail 6
Khlebnikov, Paul 51
Khodorskovsky, Mikhail xxvii,
xxviii, 10, 111
Kosmicheskaya Svyaz 159
Kozak, Dmitry 67
Krasny Vostok 208
Labour Code 311
labour productivity index 18
land acquisition stages 31819
Land Cadastre Law 33940
Land Code 35, 286, 287, 289, 333
land ownership 334, 335, 336,
28385
leasing 33839
nationally significant projects
36667
land legislation 28386
land ownership 33436
Land Register 340
land relations 28992, 321
land taxes 34
Law on Agricultural Land 286
Law on Arbitrazhniy Courts 305
Law on Auditing Activity 266, 268
Law on Banks and Banking 91
Law on the Court System 305
Law on Electronic Signatures 303
Law on Farm Land Turnover 289,
290, 291
Index
Law on Foreign Investments 236,
32425
Law on Gas Supply 124
Law on Mortgage Securities 287
Law on Registration 226, 227, 228
Law on Restructuring of Credit
Organizations 87, 88
Law on the Status of Foreigners
239, 240
Law on Trade Marks 294, 295
LDPR party 8
leases 33739
of buildings 28687
of land 285
legal entities see business
structures/entities
legal framework 3037
civil law system 3336
constitutional structure 3032
foreign investment legislation
3637
judicial system 3233
property 3536
legal system 30410
courts 30408, 305, 306
procedure 30810
legislative branch of government
3132
lending by banks 24, 27, 28, 7374,
8081
liability, representative offices
219
licensing
oil and gas industry 12021, 124
telecommunications industry
16667
limited liability companies (OOO)
21921, 23334
contribution to capital 229
formation of charter capital 229
joint stock companies compared
23436
registration 226, 228, 346
share acquisition 34748
Limited Liability Companies (LLC)
Law 91, 94, 219, 231
auditing 267
385
liquidity issues, pharmaceutical

industry 197
litigation costs 310
LLC see Limited Liability Companies
Law
loans for shares programme 102
local taxes 250
luxury clothes market 20304
management
joint stock companies 222, 232
limited liability companies 220,
234
representative offices 219
maps xx, xxi, xxii
market economy proclamation xxvi
Mass Privatization Programme
(MPP) 52, 101
MBS see Mortgage-Backed Securities
Law
McCarthy, Tim 4748
Medvedev, Dmitry 4
Mercury 20304
mergers and acquisitions 34650
assets acquisition 34849
banking sector 71
mergers 346
procedures and timing 350
purchase 34950
shares acquisition 34648
Metro 200, 203
microbrewery/brewpub market 208
mineral resources, ownership 286
MinFin Tsalak 266
minimum wage 31213
ministers 67
Ministry of Anti-Monopoly Policy
166, 22930, 235, 296
Ministry of Communications and
Information Science 16566
Ministry of Economic Developments
and Trade 276
Ministry of Finance 268, 276
Ministry of Health Communication
166
Ministry of the Interior 316
Ministry of Internal Affairs 33
Ministry of Justice 33
386
Index
Mironov, Sergei 9
monetary issues 1129
banking sector 2328, 24, 25, 26,
27, 28
exchange rate 1215, 12, 13,
1720, 18, 19
inflation 1517, 16
interest rates 2023, 20, 21, 22
Moodys xxvi, 45
Mortgage-Backed Securities (MBS)
Law 91
Mortgage Law 34143
mortgage financing 76
mortgage regulation 287, 34143
Moscow
property leasing law 337
Mosmart 203
MPP see Mass Privatization
Programme
M-Video 202
National Banking Council 70
National Council for Corporate
Governance (NSKU) 104
nationally significant investment
projects 36670
natural gas sector, structural reform
48, 49
Natural Monopolies Law 87
natural resource sector,
diversification away from 43
neighbouring rights 29799
New Currency Law 95, 9798
nominal wages averages 19
non-residents
bank accounts 96, 238
status 96
tax rates 245
non-taxable income 246
notarization requirement, mortgage
financing 76, 34142
NSKU see National Council for
Corporate Governance
OAO see joint stock companies
Obi 200
Obligatory Pension Insurance 255,

261
Ochakovo 208, 209
oil industry 10914, 11522
consumption 13940
dependence on 63
key investment issues 11722
pipeline system 11112, 112,
11819
production levels 10910, 110,
116, 117
regulatory and legal environment
12327
supply 143
oil prices 13
oligarchs, limiting power of
xxixxxx, 910, 50
OOO see limited liability companies
open joint stock companies 22124,
233
ownership
buildings 33637
concentration xxixxxx
land 33436
PAC (Presidential Audit Commission)
266
parliament 79, 3132
participants meetings, limited
liability companies 234
Patent Office 295, 296
patents 299301
registration 300
payroll taxes 255
Unified Social Tax 247
PBU (provisions on accounting)
272
PE (permanent establishment)
253
pension fund contributions 261
pension system reform 49
pension tax 255, 262
perfume retailers 203
permanent establishment (PE)
253
personal accreditation of foreign
employees 315
Index
personal income tax 34, 24547,
25657
personalities, importance in business
culture xxviiixxix, 6163
Pharmaceutical Inspection 195
pharmaceuticals market 18089,
19097
development trends 19095, 192
investment barriers 19697
retail sector 187, 187, 188, 189
size and structure 18082, 180,
181, 182
supply 18286, 183, 184, 185, 186
wholesale distribution 18687
physical line modem market segment
15657
pipeline system, energy industry
11112, 112, 11819, 127
piracy 30203
political environment xxiiixxviii,
310
investment climate 4950
problems with centralized system
6163
presidential administration 45, 31
problems with centralized system
6163
Presidential Audit Commission (PAC)
266
prime minister, role of 6
privatization 52, 10102
telecommunications industry
16465
probation periods 312
Production Sharing Agreements
(PSAs) 11314, 12526
Production Sharing Agreements
(PSA) Law 124, 12526
Procurator General 33
profitability levels, pharmaceutical
industry 196
profits, exchange rate effect 17
profits tax 34, 24244, 25153, 258
property deductions, income tax 246
property legislation 3536, 28388
buildings 28687
dispute resolution 28788
land 28386
387
mineral resources 286

mortgages 287
registration 288
property rights 33343
immovable property rights
registration 33940
leases 33739
mortgage of real estate 34143
ownership of buildings 33637
ownership of land 33436
real estate classifications 340
real estate payments 34041
residential real estate 341
property taxes 34, 248, 25556, 260
provisions on accounting (PBU) 272
PSAs see Production Sharing
Agreements
purchase of enterprises 34950
Putin, Vladimir xxiii, xxv, 3, 910
influence on business culture xxix
influence on investment climate
4950
Pyaterochka 202
RABD see Russian American
Business Dialogue
Raiffeisen Bank 80
railway system, and oil transport
118
Ramenka 200, 203
RAO UES Rossii see Unified Energy
Systems
RAS see Russian Accounting
Standards
ready-made companies 32829
real estate classifications 340
real estate payments 288, 34041
regional taxes 250
regions
debt defaults and recovery 35365
future 36165, 362
1998 crisis 35455, 354, 355
default triggers 35559
restructuring and recovery
35961, 359
retail sector 201
registration authorities 22526
388
Index
Registration Law 337

registration requirements
business entities 22530, 23637,
32829
property 288, 321
rent-seeking behaviour xxix
reorganizations, taxation 25253
reporting requirements 64
representative offices 21719, 236,
322
accreditation of foreign employees
315
registration authorities 22526,
237
registration documents 22728,
230
taxation 253
residency permits 33132
resident status 96
residential real estate 341
retail banking 2528, 7476, 7981
statistics 25, 26, 27, 28
retail industry 198204
largest retailers 20104
macroeconomic trends 199200
major trends 20001
retail pharmacy sector 187, 187,
188, 189
RF Federal Customs Service 276
risks ratings, country 5566
banking system 6566, 65
bureaucracy 5859
centralized system 6163
corporate credit ratings 5658, 57
corporate governance 5961
economic concentration 63
transparency incentives 6364
Rodina party 8
Rosenergoatom 129
Rostelecom 155, 165
Rotek 157
rouble see currency legislation;
exchange rates
RSPP see Russian Union of
Industrialists and Entrepreneurs
Rules for Resolving Disputes Over
Domain Names 302
Russian Accounting Standards (RAS)

272, 273
Russian American Business Dialogue
(RABD) 39
Russian Institute for Public Networks
30102
Russian Standard Bank 80
Russian Union of Industrialists and
Entrepreneurs (RSPP) 39, 4041
Sakhalin projects 11314, 126
Sakhalin-3 40, 62
satellite communications 15961
Sberbank 47, 75, 77
Sechin, Igor 4, 5
Second Law on insolvency 8486, 88
Securities Law 91, 92, 94
securities markets and transactions
9194
regulation 9394
stock exchange 9192
security, global 50
self-regulating organizations (SROs)
93
service sector growth 4344, 44
Services Purchasing Managers Index
(SPM) 44
services sector of IT market 169,
170
Severstal 178
Shareholder Wealth Maximization
Model (SWM) 99
shareholders
electricity industry 134
meetings 232
taxation 252
shareholding structures 64
shares
acquisition 34648
issues and transfers 22224
shopping mall development 201,
204
Siberian Aluminium (SibAl) 178
small and medium-sized enterprises
(SMEs)
bank credit problems 80
see also entrepreneurial start-ups
social deductions 24546
Index
social fund registration requirements
237
Social Insurance Contributions 255
software sector of IT market 169,
170, 171
SPM see Services Purchasing
Managers Index
squatting 30203
SROs (self-regulating organizations)
93
St. Petersburg, brewing industry
207
stakeholders, electricity industry
134
Standard & Poors xxvi, 5556
Starik Hottabych 20203
start-ups, entrepreneurial 32632
operational issues 32932
setting up a venture 32629
state arbitrazhniy (commercial)
courts 32, 33, 304, 30506, 306,
30708
State Commission on Electronic
Communication 166
State Committee for Radio
Frequencies 166
State Duma 4, 78, 32
State Registration Chamber (SRC)
226
stock exchange 9192
stock market, telecom operators in
15154, 153
storage of goods (temporary), customs
regulations 276
Strategy, Energy 136
Strategy for the Development of the
Banking Sector 76
structural reforms 4749
Sub-soil Law 123, 12425
SUN Interbrew 208, 209
supermarkets 20102
Supreme Courts 32, 33, 307, 308
Surkov, Vladislav 45
Svyazinvest 15456, 155, 159, 165
switching equipment manufacture
16162, 161
SWM see Shareholder Wealth
Maximization Model
389
tax agents 247

Tax Code 34, 241
tax incentives, abolition of 24243
tax rates
income tax 245
profit tax 243
VAT 244
tax system 34, 24149, 25057
advertising tax 256
customs duties 249
double tax treaties 26364
effect on bank lending 7374
excise tax 248
individual income tax 24547,
25657
Internet purchase 303
oil and gas industry 11213,
11920, 12526
payroll 255
Unified Social Tax 247, 255
profits tax 24244, 25153
property tax 248, 25556
registration of business entities
237
small businesses 32728
summary 25862
transport tax 256
value added tax 24445, 25354
telecommunications market 14663,
149, 16467
communications equipment
manufacture 16263, 167
communications facilities market
15662, 157, 158, 160, 161
governing agencies 16566
key players 15056, 152, 153, 155
licensing 16667
privatization 16465
volume 14748, 147, 148
territorial generation companies
132
thermal power stations 141
thin capitalization rules 251
Thuraya 161
trade marks 29497
390
Index
traditional telecom operators 150

transfer pricing 24344, 251
Transneft 118, 119, 126
Transnefteprodukt 12627
transparency and disclosure levels
6364
pharmaceutical industry 197
transport infrastructure, energy
industry 11819, 12627
transport tax 256, 261
treaties
bilateral investment 37, 323
double taxation 37, 26364, 323
intellectual property 301
Tsalak 266
TSEPKO 208
UAZ see Ural Automobile Plant
UGS see Unified Gas Transmission
Unified Energy Systems (UES) of
Russia (RAO UES Rossii)
12829
restructuring 48
Unified Gas Transmission (UGS)
119
Unified Social Tax (UST) 247, 255,
261
United Russia party 8, 61
Ural Automobile Plant (UAZ) 175,
17677
Uralsvyazinform 15455
US-Russian bilateral processes
3940
US-Russian Commercial Energy
Dialogue (CED) 40
UST see Unified Social Tax
utilities sector, structural reform 48

UVIR see Department for Visas and
Registrations
value added tax (VAT) 34, 24445,
25354, 259, 324
VEB bank 7677
Vimpelcom 61
visas 239, 316, 33132
Vneshtorgbank (VTB) 47, 7677
Voentelecom 161
VolgaTelecom 155
Volgski Automobile Plant (AvtoVAZ)
175, 176, 177
VTB (Vneshtorgbank) 47, 7677
wage, minimum statutory 31213
websites, business-related 37173
wholesale generation companies
132
withdrawal rights, limited liability
companies 221
withholding tax 243, 259
without prejudice negotiations 310
work permits 23940, 31415, 318,
33132
World Trade Organization (WTO)
accession 39, 50
Yeltsin, Boris xxiiixiv, 7
Yukos case xxvixxviii, 910, 50, 60,
61, 111
Kenneth Dart 10304
ZAO see joint stock companies
Zhukov, Alexander 6
Index of Advertisers
Adam Smith Conferences
Argus Media
ITE Group plc
SGS

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GLOBAL MARKET BRIEFINGS

doing business with

A GUIDE TO INVESTMENT OPPORTUNITIES

Andrew B Somers, President, American Chamber of Commerce in Russia

PART ONE: BACKGROUND TO THE MARKET

Developments in the Political Environment

An Overview of the Russian Economy: Money Matters

The Legal Regime and Regulatory Environment for

CMS Cameron McKenna

Latest Developments in the Foreign Investment Climate

Andrew B Somers, President, American Chamber of Commerce

The Russian Investment Climate

Russian Country Risk: Clouding Future Prospects for

Elena Anankina and Robert E Richards, Standard & Poors

The Russian Banking System: An Overview

Eric Zuy, Allen & Overy

Deloitte & Touche

Twelve Years of the Russian Insolvency Regime

Eric Zuy, Allen & Overy

The Issuance and Regulation of Securities

Max Gutbrod, Partner, Baker & McKenzie CIS, Limited

Corporate Governance Development in Russia

Russian Oil and Gas

Bill Page and Mark Redhead, Deloitte

The Business Climate in the Russian Oil and Gas Sector

Keith Rowden, Leader, Energy Industry Services and Igor Lotakov,

The Oil and Gas Industry: The Regulatory Environment and

CMS Cameron McKenna

Investing in a Reforming Electric Utilities Industry

Alexander Chmel, Partner and Vyacheslav Solomin, Senior Manager,

Russian Energy Sector Policy

Sergey Maslichenko, OTAC Limited

The Telecommunications Market

Vyacheslav Masenkov, Deputy General-Director and

Telecommunications: The Regulatory Framework

CMS Cameron McKenna

The Russian IT Market

Vyacheslav Masenkov, Deputy General-Director and

The Automotive Industry

Alexander Raifeld and Andrei Kouzmin, Deloitte & Touche

3.10 The Pharmaceuticals Market

Anton Timergaliev, Senior Market Analyst, RMBC

3.11 Investing in Russian Pharmaceuticals: Crisis or Renaissance? 190

3.12 The Development of Retail

Alexander Raifeld and Andrei Kouzmin, Deloitte & Touche

3.13 The Brewing Industry

Deloitte & Touche

CMS Cameron McKenna

CMS Cameron McKenna

Russian Business Entities

Paul Quigley, Deloitte & Touche

Natalia Milchakova, Tax Partner, PricewaterhouseCoopers, Moscow

Auditing and Accounting

Andrei Elinson, Deloitte & Touche

New Russian Customs Legislation

Alexander Dragunov, Director, Customs Practice,

The Property Regime in Russia

CMS Cameron McKenna

Land Relations in the Russian Federation

Andrey Goltsblat, Managing Partner, Pepeliaev, Goltsblat & Partners

Intellectual Property and E-Commerce

CMS Cameron McKenna

Arbitration and Dispute Resolution

CMS Cameron McKenna